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The Response of Term Rates to Monetary Policy Uncertainty

Author

Listed:
  • Oscar Jorda

    (University of California, DavisA)

  • Kevin Salyer

    (University of California, Davis)

Abstract

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)

Suggested Citation

  • Oscar Jorda & Kevin Salyer, 2003. "The Response of Term Rates to Monetary Policy Uncertainty," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(4), pages 941-962, October.
  • Handle: RePEc:red:issued:v:6:y:2003:i:4:p:941-962 DOI: 10.1016/S1094-2025(03)00022-X
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    Cited by:

    1. Harm Bandholz & Jorg Clostermann & Franz Seitz, 2009. "Explaining the US bond yield conundrum," Applied Financial Economics, Taylor & Francis Journals, pages 539-550.
    2. Marfatia, Hardik A., 2015. "Monetary policy's time-varying impact on the US bond markets: Role of financial stress and risks," The North American Journal of Economics and Finance, Elsevier, vol. 34(C), pages 103-123.
    3. Dudley Cooke, 2016. "Optimal Monetary Policy with Endogenous Export Participation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 21, pages 72-88, July.
    4. Harm Bandholz & Jorg Clostermann & Franz Seitz, 2009. "Explaining the US bond yield conundrum," Applied Financial Economics, Taylor & Francis Journals, pages 539-550.
    5. De Paoli, Bianca & Scott, Alasdair & Weeken, Olaf, 2010. "Asset pricing implications of a New Keynesian model," Journal of Economic Dynamics and Control, Elsevier, vol. 34(10), pages 2056-2073, October.
    6. Òscar Jordà, 2005. "Estimation and Inference of Impulse Responses by Local Projections," American Economic Review, American Economic Association, pages 161-182.
    7. Uluc Aysun, 2006. "Testing for Balance Sheet Effects in Emerging Market Countries," Working papers 2006-28, University of Connecticut, Department of Economics.
    8. Oscar Jorda, 2003. "Model-Free Impulse Responses," Working Papers 38, University of California, Davis, Department of Economics.
    9. repec:onb:oenbwp:y::i:93:b:1 is not listed on IDEAS
    10. Scharler, Johann, 2008. "Bank lending and the stock market's response to monetary policy shocks," International Review of Economics & Finance, Elsevier, vol. 17(3), pages 425-435.
    11. Chanda, Areendam, 2008. "The rise in returns to education and the decline in household savings," Journal of Economic Dynamics and Control, Elsevier, pages 436-469.
    12. Don Bredin & Stilianos Fountas, 2008. "Macroeconomic Uncertainty and Performance in the European Union and Implications for the objectives of Monetary Policy," Discussion Paper Series 2008_01, Department of Economics, University of Macedonia, revised Jan 2008.
    13. Timothy Cogley, 2005. "Changing Beliefs and the Term Structure of Interest Rates: Cross-Equation Restrictions with Drifting Parameters," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(2), pages 420-451, April.

    More about this item

    Keywords

    Limited participation; Term structure; Mean preserving spread; Multivariate GARCH; GARCH-SVAR;

    JEL classification:

    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • C4 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics

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