Federal Reserve Credibility and the Market's Response to the Weekly M1 Announcements

This paper provides new evidence on the issue of Federal Reserve System credibility by examining the response pattern of asset prices to the weekly M1 announcements under different operating procedures and monetary policy regimes in the September 1977 to December 1984 period. It is found that the response of asset prices to money surprises represented revisions of inflationary expectations in the pre-October 6, 1979, period and that the Federal Reserve was not credible. On the contrary, the response of asset prices to money surprises represented revisions of real interest rates in the post-October 6, 1979, period and the Federal Reserve was credible. Furthermore, the evidence shows that the October 1982 return to an interest-rate-smoothing procedure did not result in any loss of the System’s credibility, suggesting that credibility, once attained, does not depend on the short- run operating procedure.