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Asymmetric monetary policy and the yield curve

  • Bhansali, Vineer
  • Dorsten, Matthew P.
  • Wise, Mark B.
Registered author(s):

    We discuss the Taylor rule near low inflation and interest rates. Using an additional option-like term in the Federal Reserve's loss function (i.e., the "deflation put") we extend the classic Taylor rule to one with an asymmetric response that is more accommodative when the inflation rate is very low. Once calibrated, this payoff profile gives an exact, and easily communicable prescription for Federal Reserve policy under regimes of low inflation. Simple models of central bank behavior can produce highly complex yield curve shapes. Using the usual Taylor rule and our proposed extension as building blocks, we construct a robust framework for generating realistic yield curves and the evolution of the economy. Our main focus is the impact on the yield curve and the economy of the "deflation put". We find that for economies like the U.S. the deflation put reduces yields for all maturities. We also find that in highly leveraged economies (such as Japan) the consequence of an asymmetric deflation fighting policy may result in improved economic conditions, but also raises the possibility of higher long-term yields as a consequence.

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    File URL: http://www.sciencedirect.com/science/article/pii/S0261-5606(09)00100-4
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    Article provided by Elsevier in its journal Journal of International Money and Finance.

    Volume (Year): 28 (2009)
    Issue (Month): 8 (December)
    Pages: 1408-1425

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    Handle: RePEc:eee:jimfin:v:28:y:2009:i:8:p:1408-1425
    Contact details of provider: Web page: http://www.elsevier.com/locate/inca/30443

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    1. Dewachter, Hans & Lyrio, Marco, 2006. "Macro Factors and the Term Structure of Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(1), pages 119-140, February.
    2. Hordahl, Peter & Tristani, Oreste & Vestin, David, 2006. "A joint econometric model of macroeconomic and term-structure dynamics," Journal of Econometrics, Elsevier, vol. 131(1-2), pages 405-444.
    3. Siklos, Pierre L. & Werner, Thomas & Bohl, Martin T., 2004. "Asset Prices in Taylor Rules: Specification, Estimation, and Policy Implications for the ECB," Discussion Paper Series 1: Economic Studies 2004,22, Deutsche Bundesbank, Research Centre.
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    7. Clarida, R. & Gali, J. & Gertler, M., 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and some Theory," Working Papers 98-01, C.V. Starr Center for Applied Economics, New York University.
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    9. Charles L. Evans & David A. Marshall, 2001. "Economic determinants of the nominal treasury yield curve," Working Paper Series WP-01-16, Federal Reserve Bank of Chicago.
    10. Gauti B. Eggertsson & Michael Woodford, 2003. "The Zero Bound on Interest Rates and Optimal Monetary Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(1), pages 139-235.
    11. Ang, Andrew & Piazzesi, Monika & Wei, Min, 2006. "What does the yield curve tell us about GDP growth?," Journal of Econometrics, Elsevier, vol. 131(1-2), pages 359-403.
    12. L Christopher Plantier & Dean Scrimgeour, 2002. "Estimating a Taylor Rule for New Zealand with a time-varying neutral real rate," Reserve Bank of New Zealand Discussion Paper Series DP2002/06, Reserve Bank of New Zealand.
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    14. Jeffrey C. Fuhrer, 1996. "Monetary Policy Shifts and Long-Term Interest Rates," The Quarterly Journal of Economics, Oxford University Press, vol. 111(4), pages 1183-1209.
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