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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. Goodfriend, Marvin, 1991. "Interest rates and the conduct of monetary policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 34(1), pages 7-30, January.
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  3. Campbell, John Y & Shiller, Robert J, 1991. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," Review of Economic Studies, Wiley Blackwell, vol. 58(3), pages 495-514, May.
  4. Pierluigi Balduzzi & Giuseppe Bertola & Silverio Foresi, 1993. "A Model of Target Changes and the Term Structure of Interest Rates," NBER Working Papers 4347, National Bureau of Economic Research, Inc.
  5. Frederic S. Mishkin & John Simon, 1994. "An Empirical Examination of the Fisher Effect in Australia," RBA Research Discussion Papers rdp9410, Reserve Bank of Australia.
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  7. Mankiw, N Gregory & Miron, Jeffrey A, 1986. "The Changing Behavior of the Term Structure of Interest Rates," The Quarterly Journal of Economics, MIT Press, vol. 101(2), pages 211-28, May.
  8. Campbell, John Y & Shiller, Robert J, 1987. "Cointegration and Tests of Present Value Models," Journal of Political Economy, University of Chicago Press, vol. 95(5), pages 1062-88, October.
  9. Robert J. Shiller & John Y. Campbell & Kermit L. Schoenholtz, 1983. "Forward Rates and Future Policy: Interpreting the Term Structure of Interest Rates," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 14(1), pages 173-224.
  10. William Roberds & Charles H. Whiteman, 1996. "Endogenous term premia and anomalies in the term structure of interest rates: explaining the predictability smile," Working Paper 96-11, Federal Reserve Bank of Atlanta.
  11. Stefan Gerlach & Frank Smets, 1995. "The term structure of Euro-rates: some evidence in support of the expectations hypothesis," BIS Working Papers 28, Bank for International Settlements.
  12. 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.
  13. 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.
  14. Evans, Charles L. & Marshall, David A., 1998. "Monetary policy and the term structure of nominal interest rates: Evidence and theory," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 49(1), pages 53-111, December.
  15. Alessandro Prati & Giuseppe Bertola & Leonardo Bartolini, 2000. "Day-To-Day Monetary Policy and the Volatility of the Federal Funds Interest Rate," IMF Working Papers 00/206, International Monetary Fund.
  16. 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.
  17. Sola, Martin & Driffill, John, 1994. "Testing the term structure of interest rates using a stationary vector autoregression with regime switching," Journal of Economic Dynamics and Control, Elsevier, vol. 18(3-4), pages 601-628.
  18. Andrew Ang & Geert Bekaert, 1998. "Regime Switches in Interest Rates," NBER Working Papers 6508, National Bureau of Economic Research, Inc.
  19. Mankiw, N Gregory & Miron, Jeffrey A & Weil, David N, 1987. "The Adjustment of Expectations to a Change in Regime: A Study of the Founding of the Federal Reserve," American Economic Review, American Economic Association, vol. 77(3), pages 358-74, June.
  20. Stefan Gerlach & Frank Smets, 1997. "Exchange rate regimes and the expectations hypothesis of the term structure," BIS Working Papers 43, Bank for International Settlements.
  21. Pierluigi Balduzzi & Giuseppe Bertola & Silverio Foresi & Leora Klapper, 1997. "Interest Rate Targeting and the Dynamics of Short-Term Rates," NBER Working Papers 5944, National Bureau of Economic Research, Inc.
  22. Hamilton, James D., 1988. "Rational-expectations econometric analysis of changes in regime : An investigation of the term structure of interest rates," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 385-423.
  23. 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.
  24. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "A Theory of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 53(2), pages 385-407, March.
  25. Mark Fisher & Christian Gilles, 1998. "Around and Around: The Expectations Hypothesis," Journal of Finance, American Finance Association, vol. 53(1), pages 365-383, 02.
  26. Vilmunen, Jouko, 1998. "Macroeconomic Effects of Looming Policy Shifts: Non-falsified Expectations and Peso Problems," Research Discussion Papers 13/1998, Bank of Finland.
  27. Engsted, Tom & Tanggaard, Carsten, 1994. "Cointegration and the US term structure," Journal of Banking & Finance, Elsevier, vol. 18(1), pages 167-181, January.
  28. Shiller, Robert J. & Huston McCulloch, J., 1990. "The term structure of interest rates," Handbook of Monetary Economics, in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 1, chapter 13, pages 627-722 Elsevier.
  29. Sharon Kozicki & P.A. Tinsley, 1998. "Term structure views of monetary policy," Research Working Paper 98-07, Federal Reserve Bank of Kansas City.
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