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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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Suggested Citation

  • Bennett T. McCallum, 2005. "Monetary policy and the term structure of interest rates," Economic Quarterly, Federal Reserve Bank of Richmond, vol. 91(Fall), pages 1-21.
  • Handle: RePEc:fip:fedreq:y:2005:i:fall:p:1-21:n:v.91no.4
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    References listed on IDEAS

    as
    1. Froot, Kenneth A, 1989. " New Hope for the Expectations Hypothesis of the Term Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 44(2), pages 283-305, June.
    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. Jeffrey C. Fuhrer, 1995. "Monetary policy and the behavior of long-term real interest rates," New England Economic Review, Federal Reserve Bank of Boston, issue Sep, pages 39-52.
    4. Peter Kugler, 1988. "An Empirical Note on the Term Structure and Interest Rate Stabilization Policies," The Quarterly Journal of Economics, Oxford University Press, vol. 103(4), pages 789-792.
    5. 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.
    6. Jeffrey C. Fuhrer & George R. 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.
    7. N. Gregory Mankiw & Jeffrey A. Miron, 1986. "The Changing Behavior of the Term Structure of Interest Rates," The Quarterly Journal of Economics, Oxford University Press, vol. 101(2), pages 211-228.
    8. Fama, Eugene F., 1984. "The information in the term structure," Journal of Financial Economics, Elsevier, vol. 13(4), pages 509-528, December.
    9. 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.
    10. John Y. Campbell & Robert J. Shiller, 1991. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," Review of Economic Studies, Oxford University Press, vol. 58(3), pages 495-514.
    11. 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.
    12. Robert D. Laurent, 1988. "An interest rate-based indicator of monetary policy," Economic Perspectives, Federal Reserve Bank of Chicago, vol. 12(Jan), pages 3-14.
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    More about this item

    Keywords

    Monetary policy; Interest rates;

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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