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The Response of Term Rates to Monetary Policy Uncertainty

  • Oscar Jorda

    (University of California, Davis)

  • Kevin Salyer

    (University of California, Davis)

This paper shows that greater uncertainty about monetary policy can lead to a decline in nominal interest rates. In the context of a limited participation model, monetary policy uncertainty is modeled as a mean preserving spread in the distribution for the money growth process. This increase in uncertainty lowers the yield on short-term maturity bonds because the household sector responds by increasing liquidity in the banking sector. Long-term maturity bonds also have lower yields but this decrease is a result of the effect that greater uncertainty has on the nominal intertemporal rate of substitution––which is a convex function of money growth. We examine the nature of these relations empirically by introducing the GARCH-SVAR model––a multivariate generalization of the GARCH-M model. The predictions of the model are broadly supported by the data: higher uncertainty in the federal funds rate can lower the yields of the three- and six-month treasury bill rates. (Copyright: Elsevier)

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Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 6 (2003)
Issue (Month): 4 (October)
Pages: 941-962

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Handle: RePEc:red:issued:v:6:y:2003:i:4:p:941-962
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  1. Maurice Obstfeld and Kenneth Rogoff., 1999. "New Directions for Stochastic Open Economy Models," Center for International and Development Economics Research (CIDER) Working Papers C99-107, University of California at Berkeley.
  2. Brian P. Sack & Volker W. Wieland, 1999. "Interest-rate smoothing and optimal monetary policy: a review of recent empirical evidence," Finance and Economics Discussion Series 1999-39, Board of Governors of the Federal Reserve System (U.S.).
  3. Dotsey, Michael & Sarte, Pierre Daniel, 2000. "Inflation uncertainty and growth in a cash-in-advance economy," Journal of Monetary Economics, Elsevier, vol. 45(3), pages 631-655, June.
  4. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1997. "Monetary policy shocks: what have we learned and to what end?," Working Paper Series, Macroeconomic Issues WP-97-18, Federal Reserve Bank of Chicago.
  5. Michael Woodford, 1999. "Optimal Monetary Policy Inertia," NBER Working Papers 7261, National Bureau of Economic Research, Inc.
  6. James D. Hamilton & Oscar Jorda, 2000. "A Model for the Federal Funds Rate Target," NBER Working Papers 7847, National Bureau of Economic Research, Inc.
  7. Lawrence J. Christiano & Martin Eichenbaum, 1991. "Identification and the Liquidity Effect of a Monetary Policy Shock," NBER Working Papers 3920, National Bureau of Economic Research, Inc.
  8. Kevin Salyer & Harris Dellas, 2003. "Some Fiscal Implications of Monetary Policy," Working Papers 21, University of California, Davis, Department of Economics.
  9. Charles L. Evans & David A. Marshall, 1997. "Monetary policy and the term structure of nominal interest rates: evidence and theory," Working Paper Series, Macroeconomic Issues WP-97-10, Federal Reserve Bank of Chicago.
  10. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1996. "Sticky price and limited participation models of money: a comparison," Staff Report 227, Federal Reserve Bank of Minneapolis.
  11. Robert J. Hodrick, 1987. "Risk, Uncertainty and Exchange Rates," NBER Working Papers 2429, National Bureau of Economic Research, Inc.
  12. Oscar Jorda & Kevin Hoover, 2003. "Measuring Systematic Monetary Policy," Working Papers 05, University of California, Davis, Department of Economics.
  13. Athanasios Orphanides, 1998. "Monetary policy rules based on real-time data," Finance and Economics Discussion Series 1998-03, Board of Governors of the Federal Reserve System (U.S.).
  14. Jordi Galí, 1992. "How Well Does The IS-LM Model Fit Postwar U. S. Data?," The Quarterly Journal of Economics, Oxford University Press, vol. 107(2), pages 709-738.
  15. Sims, Christopher A. & Zha, Tao, 2006. "Does Monetary Policy Generate Recessions?," Macroeconomic Dynamics, Cambridge University Press, vol. 10(02), pages 231-272, April.
  16. Bollerslev, Tim, 1990. "Modelling the Coherence in Short-run Nominal Exchange Rates: A Multivariate Generalized ARCH Model," The Review of Economics and Statistics, MIT Press, vol. 72(3), pages 498-505, August.
  17. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1994. "Identification and the effects of monetary policy shocks," Working Paper Series, Macroeconomic Issues 94-7, Federal Reserve Bank of Chicago.
  18. Olivier Blanchard & John Simon, 2001. "The Long and Large Decline in U.S. Output Volatility," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 32(1), pages 135-174.
  19. Kevin D. Salyer & George A. Slotsve, 1993. "Time-Varying Technological Uncertainty and Asset Prices," Canadian Journal of Economics, Canadian Economics Association, vol. 26(2), pages 392-416, May.
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