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The Response of Term Rates to Monetary Policy Uncertainty

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  • Oscar Jorda

    (University of California, Davis)

  • Kevin Salyer

    (University of California, Davis)

Abstract

This paper shows that greater uncertainty about monetary policy can lead to a decline in nominal interest rates. In the context of a limited participation model, monetary policy uncertainty is modeled as a mean preserving spread in the distribution for the money growth process. This increase in uncertainty lowers the yield on short-term maturity bonds because the household sector responds by increasing liquidity in the banking sector. Long-term maturity bonds also have lower yields but this decrease is a result of the effect that greater uncertainty has on the nominal intertemporal rate of substitution––which is a convex function of money growth. We examine the nature of these relations empirically by introducing the GARCH-SVAR model––a multivariate generalization of the GARCH-M model. The predictions of the model are broadly supported by the data: higher uncertainty in the federal funds rate can lower the yields of the three- and six-month treasury bill rates. (Copyright: Elsevier)

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File URL: http://dx.doi.org/10.1016/S1094-2025(03)00022-X
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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): 6 (2003)
Issue (Month): 4 (October)
Pages: 941-962

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Handle: RePEc:red:issued:v:6:y:2003:i:4:p:941-962

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Related research

Keywords: Limited participation; Term structure; Mean preserving spread; Multivariate GARCH; GARCH-SVAR;

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References

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  1. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1997. "Monetary policy shocks: what have we learned and to what end?," Working Paper Series, Macroeconomic Issues, Federal Reserve Bank of Chicago WP-97-18, Federal Reserve Bank of Chicago.
  2. Gali, Jordi, 1992. "How Well Does the IS-LM Model Fit Postwar U.S. Data," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 107(2), pages 709-38, May.
  3. Maurice Obstfeld & Kenneth Rogoff, 1999. "New Directions for Stochastic Open Economy Models," NBER Working Papers 7313, National Bureau of Economic Research, Inc.
  4. Oscar Jorda & Kevin Hoover, 2003. "Measuring Systematic Monetary Policy," Working Papers, University of California, Davis, Department of Economics 05, University of California, Davis, Department of Economics.
  5. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1996. "Sticky Price and Limited Participation Models of Money: A Comparison," NBER Working Papers 5804, National Bureau of Economic Research, Inc.
  6. Oscar Jorda & James D. Hamilton, 2003. "A model for the federal funds rate target," Working Papers, University of California, Davis, Department of Economics 997, University of California, Davis, Department of Economics.
  7. Michael Woodford, 1999. "Optimal monetary policy inertia," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco.
  8. Kevin Salyer & Harris Dellas, 2003. "Some Fiscal Implications of Monetary Policy," Working Papers, University of California, Davis, Department of Economics 21, University of California, Davis, Department of Economics.
  9. Hodrick, Robert J., 1989. "Risk, uncertainty, and exchange rates," Journal of Monetary Economics, Elsevier, Elsevier, vol. 23(3), pages 433-459, May.
  10. Athanasios Orphanides, 1998. "Monetary policy rules based on real-time data," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 1998-03, Board of Governors of the Federal Reserve System (U.S.).
  11. Sack, Brian & Wieland, Volker, 2000. "Interest-rate smoothing and optimal monetary policy: a review of recent empirical evidence," Journal of Economics and Business, Elsevier, Elsevier, vol. 52(1-2), pages 205-228.
  12. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1994. "Identification and the effects of monetary policy shocks," Working Paper Series, Macroeconomic Issues, Federal Reserve Bank of Chicago 94-7, Federal Reserve Bank of Chicago.
  13. Bollerslev, Tim, 1990. "Modelling the Coherence in Short-run Nominal Exchange Rates: A Multivariate Generalized ARCH Model," The Review of Economics and Statistics, MIT Press, vol. 72(3), pages 498-505, August.
  14. Olivier Blanchard & John Simon, 2001. "The Long and Large Decline in U.S. Output Volatility," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 32(1), pages 135-174.
  15. Lawrence J. Christiano & Martin Eichenbaum, 1991. "Identification and the Liquidity Effect of a Monetary Policy Shock," NBER Working Papers 3920, National Bureau of Economic Research, Inc.
  16. Charles L. Evans & David A. Marshall, 1997. "Monetary policy and the term structure of nominal interest rates: evidence and theory," Working Paper Series, Macroeconomic Issues, Federal Reserve Bank of Chicago WP-97-10, Federal Reserve Bank of Chicago.
  17. Kevin D. Salyer & George A. Slotsve, 1993. "Time-Varying Technological Uncertainty and Asset Prices," Canadian Journal of Economics, Canadian Economics Association, Canadian Economics Association, vol. 26(2), pages 392-416, May.
  18. Dotsey, Michael & Sarte, Pierre Daniel, 2000. "Inflation uncertainty and growth in a cash-in-advance economy," Journal of Monetary Economics, Elsevier, Elsevier, vol. 45(3), pages 631-655, June.
  19. Christopher A. Sims & Tao A. Zha, 1998. "Does monetary policy generate recessions?," Working Paper, Federal Reserve Bank of Atlanta 98-12, Federal Reserve Bank of Atlanta.
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Citations

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Cited by:
  1. Balázs Romhányi, 2005. "A learning hypothesis of the term structure of interest rates," Macroeconomics, EconWPA 0503001, EconWPA.
  2. Bianca De Paoli, Alasdair Scott, Olaf Weeken, 2007. "Asset pricing implications for a New Keynesian model," Money Macro and Finance (MMF) Research Group Conference 2006, Money Macro and Finance Research Group 156, Money Macro and Finance Research Group.
  3. Harm Bandholz & Jorg Clostermann & Franz Seitz, 2009. "Explaining the US bond yield conundrum," Applied Financial Economics, Taylor & Francis Journals, Taylor & Francis Journals, vol. 19(7), pages 539-550.
  4. Òscar Jordà, 2005. "Estimation and Inference of Impulse Responses by Local Projections," American Economic Review, American Economic Association, American Economic Association, vol. 95(1), pages 161-182, March.
  5. repec:onb:oenbwp:y::i:93:b:1 is not listed on IDEAS
  6. Oscar Jorda, 2004. "Model-Free Impulse Responses," Working Papers, University of California, Davis, Department of Economics 68, University of California, Davis, Department of Economics.
  7. Timothy Cogley, 2005. "Changing Beliefs and the Term Structure of Interest Rates: Cross-Equation Restrictions with Drifting Parameters," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(2), pages 420-451, April.
  8. Don Bredin & Stilianos Fountas, 2008. "Macroeconomic Uncertainty and Performance in the European Union and Implications for the objectives of Monetary Policy," Discussion Paper Series 2008_01, Department of Economics, University of Macedonia, revised Jan 2008.
  9. Uluc Aysun, 2006. "Testing for Balance Sheet Effects in Emerging Market Countries," Working papers, University of Connecticut, Department of Economics 2006-28, University of Connecticut, Department of Economics.

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