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What do you expect? : imperfect policy credibility and tests of the expectations hypothesis?

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  • Sharon Kozicki
  • P.A.Tinsley

Abstract

The expectations hypothesis is a theory of the term structure of interest rates that describes a conventional view of the transmission mechanism of monetary policy. According to the expectations hypothesis, bond rates are related to current and expected movements in the policy-controlled rate. However, empirical rejections of the expectations hypothesis are commonplace and lead many to question this description of policy transmission. This paper argues that failure to account for imperfect policy credibility may explain empirical rejections. Empirical rejections may occur even when changing anticipations of future short rates are the primary source of variation in bond rates and the standard term structure transmission channel remains valid.

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Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number RWP 01-02.

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Date of creation: 2001
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Handle: RePEc:fip:fedkrw:rwp01-02

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Keywords: Rational expectations (Economic theory) ; Inflation (Finance);

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