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Equilibrium Yield Curves and the Interest Rate Lower Bound

Author

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  • Taisuke Nakata
  • Hiroatsu Tanaka

Abstract

We study the term structure of default-free interest rates in a sticky-price model with an occasionally binding effective lower bound (ELB) constraint on interest rates and recursive preferences. The ELB constraint induces state-dependency in the dynamics of term premiums by affecting macroeconomic uncertainty and interest-rate sensitivity to economic activities. In a model calibrated to match key features of the aggregate economy and term structure dynamics in the U.S. above and at the ELB, we find that the ELB constraint typically lowers the absolute size of term premiums at the ELB and increases their volatility around the time of liftoff. The central bank's announcement to keep the policy rate at the ELB for longer than previously expected lowers the expected short rate path, but its effect on term premiums depends on the risk exposure of bonds to the macroeconomy; while the announcement increases term premiums if bonds are a hedge against economic downturns, it decreases them otherwise.

Suggested Citation

  • Taisuke Nakata & Hiroatsu Tanaka, 2016. "Equilibrium Yield Curves and the Interest Rate Lower Bound," Finance and Economics Discussion Series 2016-085, Board of Governors of the Federal Reserve System (U.S.).
  • Handle: RePEc:fip:fedgfe:2016-85
    DOI: 10.17016/FEDS.2016.085
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    References listed on IDEAS

    as
    1. van Binsbergen, Jules H. & Fernández-Villaverde, Jesús & Koijen, Ralph S.J. & Rubio-Ramírez, Juan, 2012. "The term structure of interest rates in a DSGE model with recursive preferences," Journal of Monetary Economics, Elsevier, vol. 59(7), pages 634-648.
    2. Adam, Klaus & Billi, Roberto M., 2006. "Optimal Monetary Policy under Commitment with a Zero Bound on Nominal Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(7), pages 1877-1905, October.
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    4. Gavin, William T. & Keen, Benjamin D. & Richter, Alexander W. & Throckmorton, Nathaniel A., 2015. "The zero lower bound, the dual mandate, and unconventional dynamics," Journal of Economic Dynamics and Control, Elsevier, vol. 55(C), pages 14-38.
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    8. Don H. Kim & Jonathan H. Wright, 2005. "An arbitrage-free three-factor term structure model and the recent behavior of long-term yields and distant-horizon forward rates," Finance and Economics Discussion Series 2005-33, Board of Governors of the Federal Reserve System (U.S.).
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    11. Lopez, Pier & Lopez-Salido, J. David & Vazquez-Grande, Francisco, 2015. "Nominal Rigidities and the Term Structures of Equity and Bond Returns," Finance and Economics Discussion Series 2015-64, Board of Governors of the Federal Reserve System (U.S.).
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Effective Lower Bound ; Forward Guidance ; New Keynesian Model ; Recursive Preference ; Term Premiums ; Term Structure of Interest Rates ; Yield Curves;

    JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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