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The Term Structure of Interest Rates in a New Keynesian Model with Time-Varying Macro Volatility

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  • Daniel Burren

    (SIGNAL IDUNA Reinsurance Ltd)

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    Abstract

    We show that the New Keynesian sticky price model with a cost-push shock and time-varying volatilities of driving forces can reproduce the behavior of the U.S. yield curve in the post-World War II period. Furthermore, we examine how the yield data affects the estimation of time-varying volatilities. We find that if we omit the cost-push shock, we can get very different estimates of the inflation target volatility depending on whether or not we use yield data in addition to macroeconomic data. Therefore, the cost-push shock is crucial for a good prediction of the yield curve. We finally show that the slope of the yield curve depends negatively on both the volatility of the inflation target and the volatility of the cost-push shock.

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    Bibliographic Info

    Article provided by Society for AEF in its journal Annals of Economics and Finance.

    Volume (Year): 11 (2010)
    Issue (Month): 2 (November)
    Pages: 277-299

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    Handle: RePEc:cuf:journl:y:2010:v:11:i:2:p:277-299

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    Related research

    Keywords: Term structure of interest rates; New Keynesian model; Time-varying volatility;

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    1. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," NBER Working Papers 7147, National Bureau of Economic Research, Inc.
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    14. James H. Stock & Mark W. Watson, 2005. "Understanding Changes In International Business Cycle Dynamics," Journal of the European Economic Association, MIT Press, vol. 3(5), pages 968-1006, 09.
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    16. Taeyoung Doh, 2007. "What does the yield curve tell us about the Federal Reserve's implicit inflation target?," Research Working Paper RWP 07-10, Federal Reserve Bank of Kansas City.
    17. Alejandro Justiniano & Northwestern University, 2006. "The Time Varying Volatility of Macroeconomic Fluctuations," Computing in Economics and Finance 2006 219, Society for Computational Economics.
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