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Anticipated Monetary Policy and the Dynamic Behaviour of the Term Structure of Interest Rates

  • Jääskelä, Jarkko
  • Vilmunen, Jouko

    ()

    (Bank of Finland Research)

This paper investigates the measurement of anticipated interest rate policy and the effects of these expectations on the term structure of nominal interest rates. It is shown that, under the expectations hypothesis, the level of long-term interest rates depends on three factors: the level of the monetary policy interest rate, ie the steering rate; the spread between the market interest rate and the steering rate; and market expectations of the next steering rate change. The theoretical model builds on the assumption that market participants have only imperfect knowledge of the mechanism whereby changes in the steering rate are determined. As a consequence, expectations formation, although realistic, need not be entirely rational. Steering rate changes take the form of discrete jumps and occur infrequently on a daily scale. Given these assumptions, discussion of the determination of the term structure is related to the literature on uncertainty about monetary policy regimes and small samples, ie "peso" problems. Empirical analysis based on Nelson–Siegel estimates of the daily yield curves in Finland in the period 1 January 1993 to 31 October 1997 complements the theoretical discussion. The observed differences between estimated market expectations and actual tender rate changes are quite large in the sample, particularly for the longer maturities. The approach applied in this study is promising, not only in the sense of potentially providing estimates of market expectations concerning future discrete changes in monetary policy interest rates but also in the sense of its apparent potential in accounting for the often reported poor empirical performance of the expectations hypothesis.

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File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/9912.pdf
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Paper provided by Bank of Finland in its series Research Discussion Papers with number 12/1999.

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Length: 39 pages
Date of creation: 10 Sep 1999
Date of revision:
Handle: RePEc:hhs:bofrdp:1999_012
Contact details of provider: Postal:
Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland

Web page: http://www.suomenpankki.fi/en/

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  1. Campbell, John & Shiller, Robert, 1987. "Cointegration and Tests of Present Value Models," Scholarly Articles 3122490, Harvard University Department of Economics.
  2. Bekaert, Geert & Hodrick, Robert J. & Marshall, David A., 1997. "On biases in tests of the expectations hypothesis of the term structure of interest rates," Journal of Financial Economics, Elsevier, vol. 44(3), pages 309-348, June.
  3. Shiller, Robert & Campbell, John, 1991. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," Scholarly Articles 3221490, Harvard University Department of Economics.
  4. Balduzzi, Pierluigi, et al, 1998. "Interest Rate Targeting and the Dynamics of Short-Term Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 30(1), pages 26-50, February.
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  11. N. Gregory Mankiw, 1986. "The Term Structure of Interest Rates Revisited," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 17(1), pages 61-110.
  12. Bartolini, Leonardo & Bertola, Giuseppe & Prati, Alessandro, 2002. "Day-to-Day Monetary Policy and the Volatility of the Federal Funds Interest Rate," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(1), pages 137-59, February.
  13. Mark Fisher & Christian Gilles, 1998. "Around and Around: The Expectations Hypothesis," Journal of Finance, American Finance Association, vol. 53(1), pages 365-383, 02.
  14. Aiyagari, S. Rao & Braun, R. Anton, 1998. "Some models to guide monetary policymakers," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 48(1), pages 1-42, June.
  15. Marvin Goodfriend, 1990. "Interest rates and the conduct of monetary policy," Working Paper 90-06, Federal Reserve Bank of Richmond.
  16. Sharon Kozicki & Peter A. Tinsley, 1998. "Term structure views of monetary policy," Research Working Paper 98-07, Federal Reserve Bank of Kansas City.
  17. 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.
  18. Longstaff, Francis A & Schwartz, Eduardo S, 1992. " Interest Rate Volatility and the Term Structure: A Two-Factor General Equilibrium Model," Journal of Finance, American Finance Association, vol. 47(4), pages 1259-82, September.
  19. Kozicki, Sharon & Tinsley, P. A., 2001. "Term structure views of monetary policy under alternative models of agent expectations," Journal of Economic Dynamics and Control, Elsevier, vol. 25(1-2), pages 149-184, January.
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  22. Balduzzi, Pierluigi & Bertola, Giuseppe & Foresi, Silverio, 1997. "A model of target changes and the term structure of interest rates," Journal of Monetary Economics, Elsevier, vol. 39(2), pages 223-249, July.
  23. N. Gregory Mankiw & Jeffrey A. Miron & David N. Weil, 1987. "The Adjustment of Expectations to a Change in Regime: A Study of the Founding of the Federal Reserve," NBER Working Papers 2124, National Bureau of Economic Research, Inc.
  24. Gerlach, Stefan & Smets, Frank, 1997. "Exchange Rate Regimes and the Expectations Hypothesis of the Term Structure," CEPR Discussion Papers 1752, C.E.P.R. Discussion Papers.
  25. Vilmunen, Jouko, 1998. "Macroeconomic Effects of Looming Policy Shifts: Non-falsified Expectations and Peso Problems," Research Discussion Papers 13/1998, Bank of Finland.
  26. Bekaert, Geert & Hodrick, Robert J. & Marshall, David A., 2001. "Peso problem explanations for term structure anomalies," Journal of Monetary Economics, Elsevier, vol. 48(2), pages 241-270, October.
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