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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/B6V9S-4X60T5Y-1/2/dcfa4555c3519529abb38cbab369e944
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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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