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Bond Risk Premiums and Optimal Monetary Policy

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  • Francisco Palomino

    (University of Michigan)

Abstract

The bond yield dynamics implied by a welfare-maximizing monetary policy and its credibility are explored in general equilibrium. Credibility is captured by a regime change from discretion to commitment. The policy determines the optimal output and inflation responses to a source of inflation risk. Bond yields contain compensations for this risk that depend on the policy. Credibility improvements reduce the exposure to inflation risk and bond risk premiums decline. A model calibration implies lower yield spreads, less volatile yields, and reduced deviations from the expectations hypothesis under commitment. The model suggests an explanation for changes in yield dynamics in the U.S. across different policy regimes. (Copyright: Elsevier)

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File URL: http://dx.doi.org/10.1016/j.red.2010.05.003
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Bibliographic Info

Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 15 (2012)
Issue (Month): 1 (January)
Pages: 19-40

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Handle: RePEc:red:issued:09-159

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Keywords: Affine term structure; General equilibrium; Time-varying term premiums; Monetary policy; Discretion vs. commitment;

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Citations

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Cited by:
  1. Eric Swanson, 2013. "Implications of Labor Market Frictions for Risk Aversion and Risk Premia," 2013 Meeting Papers, Society for Economic Dynamics 1137, Society for Economic Dynamics.
  2. Luis Viceira & Carolin Pflueger & John Campbell, 2014. "Monetary Policy Drivers of Bond and Equity Risks," 2014 Meeting Papers, Society for Economic Dynamics 137, Society for Economic Dynamics.
  3. Gust, Christopher & López-Salido, J David, 2010. "Monetary Policy and the Cyclicality of Risk," CEPR Discussion Papers, C.E.P.R. Discussion Papers 7727, C.E.P.R. Discussion Papers.
  4. Philippe Mueller & Mikhail Chernov, 2008. "The Term Structure of Inflation Expectations," 2008 Meeting Papers 346, Society for Economic Dynamics.
  5. Armand Fouejieu & Scott Roger, 2013. "Inflation Targeting and Country Risk," IMF Working Papers, International Monetary Fund 13/21, International Monetary Fund.
  6. Refet S. G�rkaynak & Jonathan H. Wright, 2012. "Macroeconomics and the Term Structure," Journal of Economic Literature, American Economic Association, American Economic Association, vol. 50(2), pages 331-67, June.
  7. Tanaka Hiroatsu, 2012. "Monetary Policy Regimes and the Term Structure of Interests Rates with Recursive Utility," 2012 Meeting Papers, Society for Economic Dynamics 557, Society for Economic Dynamics.

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