The identification of the response of interest rates to monetary policy actions using market-based measures of monetary policy shocks

It has become common practice to estimate the response of asset prices to monetary policy actions using market-based measures such as the unexpected change in the federal funds futures rate as proxies for monetary policy shocks. I show that because interest rates and market-based measures of monetary policy shocks respond simultaneously to all news rather than simply news about monetary policy actions, estimates of the response of interest rates to monetary policy using only monetary policy news measures are biased. I propose a methodology that corrects for this ‘joint-response bias’. The results indicate that when the bias is accounted for the response of Treasury yields to monetary policy actions is considerably smaller than previously estimated.