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The Response of Term Rates to Monetary Policy Uncertainty

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Author Info

  • 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. Athanasios Orphanides, 1998. "Monetary policy rules based on real-time data," Finance and Economics Discussion Series 1998-03, Board of Governors of the Federal Reserve System (U.S.).
  2. Maurice Obstfeld & Kenneth Rogoff, 2000. "New Directions for Stochastic Open Economy Models," International Finance 0004002, EconWPA.
  3. Kevin Hoover & Oscar Jorda, 2001. "Measuring Systematic Monetary Policy," Working Papers 610, University of California, Davis, Department of Economics.
  4. Kevin Salyer & Harris Dellas, 2003. "Some Fiscal Implications of Monetary Policy," Working Papers 21, University of California, Davis, Department of Economics.
  5. Brian Sack & Volker Wieland, 1999. "Interest-rate smoothing and optimal monetary policy: a review of recent empirical evidence," Finance and Economics Discussion Series 1999-39, Board of Governors of the Federal Reserve System (U.S.).
  6. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1996. "Sticky price and limited participation models of money: a comparison," Staff Report 227, Federal Reserve Bank of Minneapolis.
  7. 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.
  8. Christiano, Lawrence J. & Eichenbaum, Martin & Evans, Charles L., 1999. "Monetary policy shocks: What have we learned and to what end?," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 2, pages 65-148 Elsevier.
  9. 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.
  10. Woodford, M., 1999. "Optimal Monetary Policy Inertia.," Papers 666, Stockholm - International Economic Studies.
  11. Sims, Christopher A. & Zha, Tao, 2006. "Does Monetary Policy Generate Recessions?," Macroeconomic Dynamics, Cambridge University Press, vol. 10(02), pages 231-272, April.
  12. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1994. "Identification and the effects of monetary policy shocks," Working Paper Series, Macroeconomic Issues 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. James D. Hamilton & Oscar Jorda, . "A model for the federal funds rate target," Department of Economics 99-07, California Davis - Department of Economics.
  15. 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 WP-97-10, Federal Reserve Bank of Chicago.
  16. Kevin D. Salyer & George A. Slotsve, 1993. "Time-Varying Technological Uncertainty and Asset Prices," Canadian Journal of Economics, Canadian Economics Association, vol. 26(2), pages 392-416, May.
  17. Hodrick, Robert J., 1989. "Risk, uncertainty, and exchange rates," Journal of Monetary Economics, Elsevier, vol. 23(3), pages 433-459, May.
  18. Dotsey, Michael & Sarte, Pierre Daniel, 2000. "Inflation uncertainty and growth in a cash-in-advance economy," Journal of Monetary Economics, Elsevier, vol. 45(3), pages 631-655, June.
  19. Gali, Jordi, 1992. "How Well Does the IS-LM Model Fit Postwar U.S. Data," The Quarterly Journal of Economics, MIT Press, vol. 107(2), pages 709-38, May.
  20. Woodford, Michael, 1999. "Optimal monetary policy inertia," CFS Working Paper Series 1999/09, Center for Financial Studies (CFS).
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Citations

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Cited by:
  1. 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 156, Money Macro and Finance Research Group.
  2. Oscar Jorda, 2004. "Model-Free Impulse Responses," Macroeconomics 0403016, EconWPA.
  3. Balázs Romhányi, 2005. "A learning hypothesis of the term structure of interest rates," Macroeconomics 0503001, EconWPA.
  4. 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, vol. 8(2), pages 420-451, April.
  5. Bandholz, Harm & Clostermann, Jörg & Seitz, Franz, 2007. "Explaining the US bond yield conundrum," OTH im Dialog: Weidener Diskussionspapiere 2, University of Applied Sciences Amberg-Weiden (OTH).
  6. Òscar Jordà, 2005. "Estimation and Inference of Impulse Responses by Local Projections," American Economic Review, American Economic Association, vol. 95(1), pages 161-182, March.
  7. repec:onb:oenbwp:y::i:93:b:1 is not listed on IDEAS
  8. Uluc Aysun, 2006. "Testing for Balance Sheet Effects in Emerging Market Countries," Working papers 2006-28, University of Connecticut, Department of Economics.

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