Interest Rate Targeting and the Dynamics of Short-Term Rates

Abstract

We explore the link between the overnight fed funds rate, which is actively targeted by the Federal Reserve, and longer-maturity term fed funds rates. We develop a term-structure model which explicitly accounts for interest rate targeting and for the predictability of future target changes. The model is able to replicate some qualitative features of the dynamic behavior of deviations of short-term rates from the target.