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Excess Sensitivity and Volatility of Long Interest Rates: The Role of Limited Information in Bond Markets

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  • Beechey, Meredith

    () (Department of Economics, University of California, Berkeley)

Abstract

Asymmetric information between the central bank and bond markets creates an inference problem that affects the behaviour of long interest rates. This paper employs a simple macroeconomic model with a time-varying infation target to illustrate the implications of asymmetry for the sensitivity of long rates and volatility of bond returns. When the central bank's infation target is not communicated and macroeconomic shocks are imperfectly observed, bond markets infer the value of the target from noisy signals. This heightens the sensitivity of long-run infation expectations to transitory shocks, thereby raising the measured reaction of long rates to monetary policy and to infation surprises. Calibrated coe±cients from such regressions are more than twice as large when bond markets lack knowledge of the target compared with a full information scenario. Time variation in the infation target is the main source of volatility, but learning adds to the ability of the model to explain the observed volatility of returns along the yield curve.

Suggested Citation

  • Beechey, Meredith, 2004. "Excess Sensitivity and Volatility of Long Interest Rates: The Role of Limited Information in Bond Markets," Working Paper Series 173, Sveriges Riksbank (Central Bank of Sweden).
  • Handle: RePEc:hhs:rbnkwp:0173
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    Cited by:

    1. Martin Melecký & Diego Rodríguez Palenzuela & Ulf Söderström, 2009. "Inflation Target Transparency and the Macroeconomy," Central Banking, Analysis, and Economic Policies Book Series,in: Klaus Schmidt-Hebbel & Carl E. Walsh & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series (ed.), Monetary Policy under Uncertainty and Learning, edition 1, volume 13, chapter 10, pages 371-411 Central Bank of Chile.
    2. Beechey, Meredith J. & Wright, Jonathan H., 2009. "The high-frequency impact of news on long-term yields and forward rates: Is it real?," Journal of Monetary Economics, Elsevier, vol. 56(4), pages 535-544, May.
    3. Thomas Jonsson & Pär Österholm, 2012. "The properties of survey-based inflation expectations in Sweden," Empirical Economics, Springer, vol. 42(1), pages 79-94, February.
    4. Monika Piazzesi & Martin Schneider, 2007. "Equilibrium Yield Curves," NBER Chapters,in: NBER Macroeconomics Annual 2006, Volume 21, pages 389-472 National Bureau of Economic Research, Inc.
    5. Troy Davig & Jeffrey R. Gerlach, 2006. "Monetary Policy, the Bond Market, and Changes in FOMC Communication Policy," Working Papers 31, Department of Economics, College of William and Mary.
    6. Queijo von Heideken, Virginia, 2008. "Monetary Policy Regimes and the Volatility of Long-Term Interest Rates," Working Paper Series 220, Sveriges Riksbank (Central Bank of Sweden).
    7. Berument, Hakan & Froyen, Richard, 2009. "Monetary policy and U.S. long-term interest rates: How close are the linkages?," Journal of Economics and Business, Elsevier, vol. 61(1), pages 34-50.
    8. Waters, George A., 2009. "Learning, Commitment, And Monetary Policy," Macroeconomic Dynamics, Cambridge University Press, vol. 13(04), pages 421-449, September.
    9. Bergman, Mats A., 2005. "A Welfare Ranking of Two-Sided Market Regimes," Working Paper Series 185, Sveriges Riksbank (Central Bank of Sweden), revised 01 Sep 2005.

    More about this item

    Keywords

    Term structure of interest rates; yield curve; limited information; learning; excess sensitivity; excess volatility.;

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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