Interest rate term structure and the Chinese fiscal policy: a mixed frequency term structure approach

We specify a mixed-frequency Nelson–Siegel term structure (MF-NS) model with fiscal policy information to investigate the influence of fiscal policy on interest rate term structure. This paper finds the following results: First, fiscal policy information can significantly improve both the in-sample fitting and out-of-sample predictions of the Chinese yield curve. More importantly, compared with short-term bonds, the fiscal variable has a greater contribution to long-term bonds. Second, the response of the level factor of the yield curve to monetary impulse is positive, while the response to fiscal surprise is negative. Furthermore, we suggest that monetary policy shows an inflation expectation effect for the level factor. However, fiscal policy shocks on the level factor via the wealth effect. Finally, fiscal policy account for the larger forecast variance of yield curve than monetary policy does in the short forecast horizon. Meanwhile, this paper further shows that fiscal policy has a greater contribution to forecast variance of long-term yield than short-term yield.