What did they know, and when did they know it?

voted to ease monetary policy, which was widely reported as a lowering of interest rates. Although some interest rates fell with the Fed' s action, the declines were generally small, and over succeeding months market interest rates tended to rise. The yield on the Treasury' s 10-year note, for example, which had been 5.63 percent on January 30, and which closed at 5.60 percent on January 31, stood at 6.34 percent on March 29, and reached 7.03 percent by June 12. Other rates behaved similarly over this period. Such seemingly perverse moves in market interest rates have also followed other monetary policy actions, sometimes even on the day those actions were taken. Commonly, Federal Reserve moves to raise or to lower interest rates are followed by changes in market interest rates in the same direction. On May 17, 1994, however , the Fed announced a tightening of monetary policy, which some might expect would cause market interest rates to rise. Instead, many market rates immediately declined. Clearly, the statement that the Fed controls interest rates is, at best, an oversimplification. This article attempts to demystify the relationship between Federal Reserve monetary policy actions and interest rate behavior. Interest rates are set in competitive markets by factors affecting the supply of and demand for individual securities. Monetary policy actions can affect both the supply of and the demand for financial assets, and their effects depend not only on current actions but also on the public' s expectations of future policy moves. We describe in some detail the near-term behavior of government security yields following three recent Federal Reserve policy actions. On the most recent occasion, the Fed' s easing action on January 31, 1996, market yields changed little immediately following the policy move, but then yields rose over succeeding months. We contrast this experience with two other events. In early 1994, Fed policy moves to raise interest rates were associated with increases in market interest rates that might be considered greater than justified by the extent of Fed actions. Then, in May 1994, market yields declined following a Fed policy action that was widely interpreted as an effort to raise interest rates. Our review of these episodes reveals how expectations of future monetary policy actions, expectations of the effect of policy on future inflation, as well as nonmonetary influences can cause market interest rates to behave in diverse ways after apparently …