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Monetary Transmission and the Yield Curve in a Small Open Economy

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  • Mariano Kulish

    (Reserve Bank of Australia)

  • Daniel Rees

    (Reserve Bank of Australia)

Abstract

Long-term nominal interest rates in a number of inflation-targeting small open economies have tended to be highly correlated with those of the United States. This observation has recently lent support to the view that the long end of the yield curve is determined abroad. We set up and estimate a micro-founded two-block small open economy model to study the co-movement of long-term nominal interest rates of different currencies. The expectations hypothesis together with uncovered interest rate parity, which both hold in our model, can account for much of the co-movement of interest rates observed in the data.

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Bibliographic Info

Paper provided by Reserve Bank of Australia in its series RBA Research Discussion Papers with number rdp2008-03.

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Date of creation: Jun 2008
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Handle: RePEc:rba:rbardp:rdp2008-03

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Keywords: term structure of interest rates; yield curve; small open economy; DSGE model; transmission mechanism;

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  1. Peter N. Ireland, 2002. "Technology Shocks in the New Keynesian Model," Boston College Working Papers in Economics 536, Boston College Department of Economics.
  2. Jordi Gal´┐Ż & Tommaso Monacelli, 2005. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 707-734.
  3. David K. Backus, 2001. "Affine Term Structure Models and the Forward Premium Anomaly," Journal of Finance, American Finance Association, vol. 56(1), pages 279-304, 02.
  4. Alejandro Justiniano & Bruce Preston, 2009. "Can structural small open economy models account for the influence of foreign disturbances?," Working Paper Series WP-09-19, Federal Reserve Bank of Chicago.
  5. Antonio Moreno & Geert Bekaert & Seonghoon Cho, 2004. "New-Keynesian Macroeconomics and the Term Structure," 2004 Meeting Papers 388, Society for Economic Dynamics.
  6. Ben S. Bernanke & Vincent R. Reinhart & Brian P. Sack, 2004. "Monetary Policy Alternatives at the Zero Bound: An Empirical Assessment," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 35(2), pages 1-100.
  7. Lawrence J. White, 2007. "Should Wal-Mart, Real Estate Brokers, and Banks Be in Bed Together? A Principles-Based Approach to the Issues of the Separation of Banking and Commerce," Working Papers 07-21, New York University, Leonard N. Stern School of Business, Department of Economics.
  8. Kristoffer Nimark, 2007. "A Structural Model of Australia as a Small Open Economy," RBA Research Discussion Papers rdp2007-01, Reserve Bank of Australia.
  9. Knez, Peter J & Litterman, Robert & Scheinkman, Jose Alexandre, 1994. " Explorations into Factors Explaining Money Market Returns," Journal of Finance, American Finance Association, vol. 49(5), pages 1861-82, December.
  10. Shiller, Robert J, 1979. "The Volatility of Long-Term Interest Rates and Expectations Models of the Term Structure," Journal of Political Economy, University of Chicago Press, vol. 87(6), pages 1190-1219, December.
  11. Ang, Andrew & Piazzesi, Monika, 2003. "A no-arbitrage vector autoregression of term structure dynamics with macroeconomic and latent variables," Journal of Monetary Economics, Elsevier, vol. 50(4), pages 745-787, May.
  12. Thomas Lubik & Frank Schorfheide, 2006. "A Bayesian Look at the New Open Economy Macroeconomics," NBER Chapters, in: NBER Macroeconomics Annual 2005, Volume 20, pages 313-382 National Bureau of Economic Research, Inc.
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Cited by:
  1. Ken Kuttner & Tim Robinson, 2008. "Understanding the Flattening Phillips Curve," RBA Research Discussion Papers rdp2008-05, Reserve Bank of Australia.
  2. David M. Williams, 2010. "Consumption, wealth and credit liberalisation in Australia," Economics Series Working Papers 492, University of Oxford, Department of Economics.

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