The nature and impact of the market forecasting errors in the Federal funds futures market

• We study the impact of the forecasting errors arising from a monetary policy shock.
• The private sector's reaction is dependent on whether the shock is expected or unexpected.
• The shocks are more significant under discretionary policies than a rule based approach.
• Policy transmission channels are much more effective within the Bernanke rule based era.
• Transparency in Fed's policy objectives leads to improved policy transmission.

In this paper we examine the impact of the forecasting errors arising from a monetary policy shock arising in the Federal funds rate market. Our empirical results indicate that forecasting errors in the Federal funds futures market do have implications for the asset market's natural price discovery process, since expectations in this market affect long term interest rates and inflation. We also find that the price discovery process may be exacerbated if the policy transmission mechanism is more pronounced under a transparency objective because of the negative feedback loop mechanism. The results further show that the aggregate demand and inflation expectations channels appear to be much more pronounced under the Bernanke regime than Greenspan leading to a much stronger policy transmission. In fact a policy tightening through both channels would have a visibly stronger deflationary and employment impact under Bernanke relative to Greenspan.