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Dynamics of the term structure of UK interest rates

  • Bianchi, Francesco

    ()

    (Princeton University)

  • Mumtaz, Haroon

    ()

    (Bank of England)

  • Surico, Paolo

    ()

    (Bank of England)

This paper models the evolution of monetary policy, the term structure of interest rates and the UK economy across policy regimes. We model the interaction between the macroeconomy and the term structure using a time-varying VAR model augmented with the factors from the yield curve. Our results suggest that the level, slope and curvature factors display substantial time variation, with the level factor moving closely with measures of inflation expectations. Our estimates indicate a large decline in the volatility of both yield curve and macroeconomic variables around 1992, when the United Kingdom first adopted an inflation-targeting regime. During the inflation-targeting regime, monetary policy shocks have been more muted and inflation expectations have been lower than in the pre-1992 era. The link between the macroeconomy and the yield curve has also changed over time, with fluctuations in the level factor becoming less important for inflation after the Bank of England independence in 1997. Policy rates appear to have responded more systematically to inflation and unemployment in the current regime. We use our time-varying macro-finance model to revisit the evidence on the expectations hypothesis.

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Paper provided by Bank of England in its series Bank of England working papers with number 363.

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Length: 36 pages
Date of creation: 20 Mar 2009
Date of revision:
Handle: RePEc:boe:boeewp:0363
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  1. Carriero, Andrea & Favero, Carlo A. & Kaminska, Iryna, 2006. "Financial factors, macroeconomic information and the Expectations Theory of the term structure of interest rates," Journal of Econometrics, Elsevier, vol. 131(1-2), pages 339-358.
  2. Efrem Castelnuovo & Paolo Surico, 2006. "The price puzzle: fact or artefact?," Bank of England working papers 288, Bank of England.
  3. Joyce, Michael & Kaminska, Iryna & Lildholdt, Peter, 2008. "Understanding the real rate conundrum: an application of no-arbitrage finance models to the UK real yield curve," Bank of England working papers 358, Bank of England.
  4. Luca Benati and Paolo Surico, 2007. "Vector Autoregression Analysis and the Great Moderation," Discussion Papers 18, Monetary Policy Committee Unit, Bank of England.
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