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Monetary policy and rejections of the expectations hypothesis

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  • Ravenna , Federico

    ()
    (Department of Economics, University of California)

  • Seppälä , Juha

    ()
    (Department of Economics, University of Illinois)

Abstract

We study the rejection of the expectations hypothesis within a New Keynesian business cycle model. Earlier research has shown that the Lucas general equilibrium asset pricing model can account for neither sign nor magnitude of average risk premia in forward prices, and is unable to explain rejection of the expectations hypothesis. We show that a New Keynesian model with habit-formation preferences and a monetary policy feedback rule produces an upward-sloping average term structure of interest rates, procyclical interest rates, and countercyclical term spreads. In the model, as in U.S. data, inverted term structure predicts recessions. Most importantly, a New Keynesian model is able to account for rejections of the expectations hypothesis. Contrary to earlier work, we identify systematic monetary policy as a key factor behind this result. Rejection of the expectation hypothesis can be entirely explained by the volatility of just two real shocks which affect technology and preferences.

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Bibliographic Info

Paper provided by Bank of Finland in its series Research Discussion Papers with number 25/2006.

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Length: 44 pages
Date of creation: 14 Dec 2006
Date of revision:
Handle: RePEc:hhs:bofrdp:2006_025

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Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
Web page: http://www.suomenpankki.fi/en/
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Keywords: term structure of interest rates; monetary policy; sticky prices; habit formation; expectations hypothesis;

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References

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Citations

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Cited by:
  1. De Paoli, Bianca & Zabczyk, Pawel, 2011. "Cyclical risk aversion, precautionary saving and monetary policy," Bank of England working papers 418, Bank of England.
  2. Refet S. G�rkaynak & Jonathan H. Wright, 2012. "Macroeconomics and the Term Structure," Journal of Economic Literature, American Economic Association, vol. 50(2), pages 331-67, June.
  3. Christoffel, Kai & Jaccard, Ivan & Kilponen, Juha, 2011. "Government bond risk premia and the cyclicality of fiscal policy," Working Paper Series 1411, European Central Bank.
  4. Taeyoung Doh, 2009. "Yield curve in an estimated nonlinear macro model," Research Working Paper RWP 09-04, Federal Reserve Bank of Kansas City.
  5. Martin Møller Andreasen, 2008. "Explaining Macroeconomic and Term Structure Dynamics Jointly in a Non-linear DSGE Model," CREATES Research Papers 2008-43, School of Economics and Management, University of Aarhus.
  6. Juha Seppala & Federico Ravenna, 2007. "Monetary Policy, Expected Inflation, and Inflation Risk Premium," 2007 Meeting Papers 513, Society for Economic Dynamics.
  7. Francisco Palomino, 2012. "Bond Risk Premiums and Optimal Monetary Policy," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 15(1), pages 19-40, January.
  8. Luis Gil-Alana & Antonio Moreno, . "Uncovering the U.S. Term Premium: An Alternative Route," Faculty Working Papers 12/07, School of Economics and Business Administration, University of Navarra.
  9. Oreste Tristani & Gianni Amisano, 2010. "A nonlinear DSGE model of the term structure with regime shifts," 2010 Meeting Papers 234, Society for Economic Dynamics.
  10. Tanaka Hiroatsu, 2012. "Monetary Policy Regimes and the Term Structure of Interests Rates with Recursive Utility," 2012 Meeting Papers 557, Society for Economic Dynamics.
  11. Zagaglia, Paolo, 2009. "Forecasting with a DSGE Model of the term Structure of Interest Rates: The Role of the Feedback," Research Papers in Economics 2009:14, Stockholm University, Department of Economics.
  12. Ramón María-Dolores & Jesús Vázquez, 2008. "Term structure and the estimated monetary policy rule in the Eurozone," Spanish Economic Review, Springer, vol. 10(4), pages 251-277, December.
  13. Mehmet Pasaogullari & Simeon Tsonevy, 2011. "The term structure of inflation compensation in the nominal yield curve," Working Paper 1133, Federal Reserve Bank of Cleveland.
  14. Paolo Zagaglia, 2011. "Forecasting Long-Term Interest Rates with a Dynamic General Equilibrium Model of the Euro Area: The Role of the Feedback," Working Paper Series 19_11, The Rimini Centre for Economic Analysis.
  15. Michael F. Gallmeyer & Burton Hollifield & Francisco Palomino & Stanley E. Zin, 2007. "Arbitrage-Free Bond Pricing with Dynamic Macroeconomic Models," NBER Working Papers 13245, National Bureau of Economic Research, Inc.

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