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Monetary Policy and the Term Structure of Interest Rates

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  • Bennett T. McCallum

Abstract

This paper addresses a prominent empirical failure of the expectations theory of the term structure of interest rates under the assumption of rational expectations. This failure concerns the magnitude of slope coefficients in regressions of short rate (or long- rate) changes on long-short spreads. It is shown that the anomalous empirical findings can be rationalized with the expectations theory by recognition of an exogenous random (but possibly autoregressive) term premium plus the assumption that monetary policy involves smoothing of an interest rate instrument -- the short rate -- together with the responses to the prevailing level of the spread.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4938.

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Date of creation: Nov 1994
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Publication status: published as Economic Quarterly, Federal Reserve Bank of Richmond, Vol. 91, no. 4, (Fall 2005), pp. 1-21
Handle: RePEc:nbr:nberwo:4938

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  1. Campbell, John Y & Shiller, Robert J, 1991. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," Review of Economic Studies, Wiley Blackwell, vol. 58(3), pages 495-514, May.
  2. Marvin Goodfriend, 1993. "Interest rate policy and the inflation scare problem: 1979-1992," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
  3. Shiller, Robert J. & Huston McCulloch, J., 1990. "The term structure of interest rates," Handbook of Monetary Economics, in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 1, chapter 13, pages 627-722 Elsevier.
  4. Robert D. Laurent, 1988. "An interest rate-based indicator of monetary policy," Economic Perspectives, Federal Reserve Bank of Chicago, issue Jan, pages 3-14.
  5. Kenneth A. Froot, 1990. "New Hope for the Expectations Hypothesis of the Term Structure of Interest Rates," NBER Working Papers 2363, National Bureau of Economic Research, Inc.
  6. Evans, Martin D. D. & Lewis, Karen K., 1994. "Do stationary risk premia explain it all?: Evidence from the term structure," Journal of Monetary Economics, Elsevier, vol. 33(2), pages 285-318, April.
  7. Jeff Fuhrer & George Moore, 1993. "Monetary policy and the behavior of long-term interest rates," Working Papers in Applied Economic Theory 93-05, Federal Reserve Bank of San Francisco.
  8. Jeff Fuhrer & George Moore, 1993. "Monetary policy and the behavior of long-term real interest rates," Finance and Economics Discussion Series 93-16, Board of Governors of the Federal Reserve System (U.S.).
  9. Robert J. Shiller & J. Huston McCulloch, 1987. "The Term Structure of Interest Rates," NBER Working Papers 2341, National Bureau of Economic Research, Inc.
  10. Fama, Eugene F., 1984. "The information in the term structure," Journal of Financial Economics, Elsevier, vol. 13(4), pages 509-528, December.
  11. N. Gregory Mankiw & Jeffrey A. Miron, 1986. "The Changing Behavior of the Term Structure of Interest Rates," NBER Working Papers 1669, National Bureau of Economic Research, Inc.
  12. Hardouvelis, Gikas A., 1994. "The term structure spread and future changes in long and short rates in the G7 countries: Is there a puzzle?," Journal of Monetary Economics, Elsevier, vol. 33(2), pages 255-283, April.
  13. Kugler, Peter, 1988. "An Empirical Note on the Term Structure and Interest Rate Stabilization Policies," The Quarterly Journal of Economics, MIT Press, vol. 103(4), pages 789-92, November.
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