IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper or follow this series

Long-term debt pricing and monetary policy transmission under imperfect knowledge

  • Stefano Eusepi
  • Marc Giannoni
  • Bruce Preston

Under rational expectations, monetary policy is generally highly effective in stabilizing the economy. Aggregate demand management operates through the expectations hypothesis of the term structure: Anticipated movements in future short-term interest rates control current demand. This paper explores the effects of monetary policy under imperfect knowledge and incomplete markets. In this environment, the expectations hypothesis of the yield curve need not hold, a situation called unanchored financial market expectations. Whether or not financial market expectations are anchored, the private sector’s imperfect knowledge mitigates the efficacy of optimal monetary policy. Under anchored expectations, slow adjustment of interest rate beliefs limits scope to adjust current interest rate policy in response to evolving macroeconomic conditions. Imperfect knowledge represents an additional distortion confronting policy, leading to greater inflation and output volatility relative to rational expectations. Under unanchored expectations, current interest rate policy is divorced from interest rate expectations. This permits aggressive adjustment in current interest rate policy to stabilize inflation and output. However, unanchored expectations are shown to raise significantly the probability of encountering the zero lower bound constraint on nominal interest rates. The longer the average maturity structure of the public debt, the more severe is the constraint.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.newyorkfed.org/research/staff_reports/sr547.html
Download Restriction: no

File URL: http://www.newyorkfed.org/research/staff_reports/sr547.pdf
Download Restriction: no

Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 547.

as
in new window

Length:
Date of creation: 2012
Date of revision:
Handle: RePEc:fip:fednsr:547
Contact details of provider: Postal: 33 Liberty Street, New York, NY 10045-0001
Web page: http://www.newyorkfed.org/
Email:


More information through EDIRC

Order Information: Web: http://www.ny.frb.org/rmaghome/staff_rp/ Email:


References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Adam, Klaus & Marcet, Albert, 2011. "Internal rationality, imperfect market knowledge and asset prices," Journal of Economic Theory, Elsevier, vol. 146(3), pages 1224-1252, May.
  2. Bruce Preston & Stefano Eusepi, 2011. "The maturity structure of debt, monetary policy and expectations stabilization," 2011 Meeting Papers 1287, Society for Economic Dynamics.
  3. Stefano Eusepi & Bruce Preston, 2010. "Debt, Policy Uncertainty and Expectations Stabilization," CAMA Working Papers 2010-20, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:fip:fednsr:547. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Amy Farber)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.