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Monetary Policy and Market Interest Rates

  • Ellingsen, Tore


    (Dept. of Economics, Stockholm School of Economics)

  • Söderström, Ulf


    (Research Department, Sveriges Riksbank)

We investigate, theoretically and empirically, the relationship between monetary policy and the term structure of interest rates. In particular, we show in a dynamic macroeconomic model that if monetary policy reveals information about economic developments, interest rates of all maturities move in the same direction in response to a policy innovation. If, on the other hand, monetary policy reveals information about the central bank's policy preferences, short and long interest rates move in opposite directions. In the empirical section, we provide direct measures of endogenous and exogenous monetary policy innovations in the U.S. by analyzing the reaction of financial market participants to Federal Reserve policy moves. The empirical findings support the theoretical predictions.

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Paper provided by Stockholm School of Economics in its series SSE/EFI Working Paper Series in Economics and Finance with number 242.

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Length: 47 pages
Date of creation: 28 May 1998
Date of revision: 08 Mar 1999
Publication status: Published in American Economic Review, 2001, pages 1594-1607.
Handle: RePEc:hhs:hastef:0242
Contact details of provider: Postal: The Economic Research Institute, Stockholm School of Economics, P.O. Box 6501, 113 83 Stockholm, Sweden
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  1. Yash P. Mehra, 1996. "Monetary policy and long-term interest rates," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 27-49.
  2. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "The science of monetary policy: A new Keynesian perspective," Economics Working Papers 356, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 1999.
  3. Ball, Laurence, 1999. "Efficient Rules for Monetary Policy," International Finance, Wiley Blackwell, vol. 2(1), pages 63-83, April.
  4. McCallum, Bennett T & Nelson, Edward, 1999. "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 296-316, August.
  5. Backus, David & Driffill, John, 1986. "The Consistency of Optimal Policy in Stochastic Rational Expectations Models," CEPR Discussion Papers 124, C.E.P.R. Discussion Papers.
  6. Svensson, Lars E.O., 1997. "Inflation Targeting: Some Extensions," Seminar Papers 625, Stockholm University, Institute for International Economic Studies.
  7. Glenn D. Rudebusch & Lars E. O. Svensson, 1998. "Policy Rules for Inflation Targeting," NBER Working Papers 6512, National Bureau of Economic Research, Inc.
  8. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
  9. Soderlind, Paul, 1999. "Solution and estimation of RE macromodels with optimal policy," European Economic Review, Elsevier, vol. 43(4-6), pages 813-823, April.
  10. Blinder, Alan S, 1997. "Is There a Core of Practical Macroeconomics That We Should All Believe?," American Economic Review, American Economic Association, vol. 87(2), pages 240-43, May.
  11. Bernanke, Ben & Gertler, Mark, 1995. "Inside the Black Box: The Credit Channel of Monetary Policy Transmission," Working Papers 95-15, C.V. Starr Center for Applied Economics, New York University.
  12. Ric Battellino & John Broadbent & Philip Lowe, 1997. "The Implementation of Monetary Policy in Australia," RBA Research Discussion Papers rdp9703, Reserve Bank of Australia.
  13. N. Gregory Mankiw & Jeffrey A. Miron, 1985. "The Changing Behavior of the Term Structure of Interest Rates," NBER Working Papers 1669, National Bureau of Economic Research, Inc.
  14. Bennett T. McCallum, 1994. "Monetary Policy and the Term Structure of Interest Rates," NBER Working Papers 4938, National Bureau of Economic Research, Inc.
  15. David H. Romer & Christina D. Romer, 2000. "Federal Reserve Information and the Behavior of Interest Rates," American Economic Review, American Economic Association, vol. 90(3), pages 429-457, June.
  16. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July.
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