The Equilibrium Fed Funds Rate and the Indicator Properties of Term Structure Spreads

This paper introduces a model-based measure of the equilibrium federal funds rate and examines the indicator properties of the spread between observed and equilibrium rates. The results are compared to those of existing studies, which implicitly use long-term interest rates to proxy the equilibrium funds rate. Granger-causality tests suggest that different measures of the term-structure spread are dominated by the funds-rate spread as a forecaster of a wide range of macroeconomic variables. These results are supported by variance-decomposition analysis. The paper also estimates simple VARs to discuss how the policy stance responds to macroeconomic shocks