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Monetary Policy Regimes and the Volatility of Long-Term Interest Rates

  • Queijo von Heideken, Virginia

    ()

    (Research Department, Central Bank of Sweden)

This paper addresses two important questions that have, so far, been studied separately in the literature. First, the paper aims at explaining the high volatility of long-term interest rates observed in the data, which is hard to replicate using standard macro models. Building a small-scale macroeconomic model and estimating it on U.S. and U.K. data, I show that the policy responses of a central bank that is uncertain about the natural rate of unemployment can explain this volatility puzzle. Second, the paper aims at shedding new light on the distinction between rules and discretion in monetary policy. My empirical results show that using yield curve data may facilitate the empirical discrimination between different monetary policy regimes and that U.S. monetary policy is best understood as originating from a discretionary regime since 1960.

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Paper provided by Sveriges Riksbank (Central Bank of Sweden) in its series Working Paper Series with number 220.

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Length: 53 pages
Date of creation: 01 Feb 2008
Date of revision:
Handle: RePEc:hhs:rbnkwp:0220
Contact details of provider: Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden
Phone: 08 - 787 00 00
Fax: 08-21 05 31
Web page: http://www.riksbank.com/
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  1. Ellingsen, Tore & Söderström, Ulf, 1998. "Monetary Policy and Market Interest Rates," SSE/EFI Working Paper Series in Economics and Finance 242, Stockholm School of Economics, revised 08 Mar 1999.
  2. Tore Ellingsen & Ulf Soderstrom, 2004. "Why are Long Rates Sensitive to Monetary Policy," Working Papers 256, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  3. Aoki, Kosuke, 2003. "On the optimal monetary policy response to noisy indicators," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 501-523, April.
  4. Seonghoon Cho & Antonio Moreno & Geert Bekaert, 2005. "New-Keynesian Macroeconomics and the Term Structure," Faculty Working Papers 04/05, School of Economics and Business Administration, University of Navarra.
  5. Peter Hördahl & Oreste Tristani & David Vestin, 2008. "The Yield Curve and Macroeconomic Dynamics," Economic Journal, Royal Economic Society, vol. 118(533), pages 1937-1970, November.
  6. Timothy Cogley & Thomas Sargent, . "Drifts and Volatilities: Monetary Policies and Outcomes in the Post WWII US," Working Papers 2133503, Department of Economics, W. P. Carey School of Business, Arizona State University.
  7. Clarida, R. & Gali, J. & Gertler, M., 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Working Papers 99-13, C.V. Starr Center for Applied Economics, New York University.
  8. Svensson, Lars E. O. & Woodford, Michael, 2001. "Indicator Variables for Optimal Policy under Asymmetric Information," Seminar Papers 689, Stockholm University, Institute for International Economic Studies.
  9. Refet S. Gürkaynak & Brian Sack & Eric Swanson, 2003. "The excess sensitivity of long-term interest rates: evidence and implications for macroeconomic models," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  10. Reis Ricardo, 2003. "Where Is the Natural Rate? Rational Policy Mistakes and Persistent Deviations of Inflation from Target," The B.E. Journal of Macroeconomics, De Gruyter, vol. 3(1), pages 1-40, September.
  11. Glenn D. Rudebusch & Tao Wu, 2003. "A macro-finance model of the term structure, monetary policy, and the economy," Working Paper Series 2003-17, Federal Reserve Bank of San Francisco.
  12. 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).
  13. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "Monetary policy rules and macroeconomic stability: Evidence and some theory," Economics Working Papers 350, Department of Economics and Business, Universitat Pompeu Fabra, revised May 1999.
  14. Shiller, Robert J, 1979. "The Volatility of Long-Term Interest Rates and Expectations Models of the Term Structure," Journal of Political Economy, University of Chicago Press, vol. 87(6), pages 1190-1219, December.
  15. Soderlind, Paul, 1999. "Solution and estimation of RE macromodels with optimal policy," European Economic Review, Elsevier, vol. 43(4-6), pages 813-823, April.
  16. Peter N. Ireland, 1998. "Does the Time-Consistency Problem Explain the Behavior of Inflation in the United States?," Boston College Working Papers in Economics 415, Boston College Department of Economics.
  17. Athanasios Orphanides & John C. Williams, 2003. "Robust monetary policy rules with unknown natural rates," Finance and Economics Discussion Series 2003-11, Board of Governors of the Federal Reserve System (U.S.).
  18. Olivier Blanchard & Jordi Gali, 2007. "A New Keynesian Model with Unemployment," Kiel Working Papers 1335, Kiel Institute for the World Economy.
  19. Shiller, Robert & Campbell, John, 1991. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," Scholarly Articles 3221490, Harvard University Department of Economics.
  20. Lawrence J. Christiano & Terry J. Fitzgerald, 2003. "Inflation and monetary policy in the twentieth century," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q I, pages 22-45.
  21. Refet S. Gürkaynak & Brian Sack & Eric Swanson, 2005. "The Sensitivity of Long-Term Interest Rates to Economic News: Evidence and Implications for Macroeconomic Models," American Economic Review, American Economic Association, vol. 95(1), pages 425-436, March.
  22. Hördahl, Peter & Tristani, Oreste & Vestin, David, 2004. "A joint econometric model of macroeconomic and term structure dynamics," Working Paper Series 0405, European Central Bank.
  23. Svensson, Lars & Woodford, Michael, 2000. "Indicator Variables for Optimal Policy," Seminar Papers 688, Stockholm University, Institute for International Economic Studies.
  24. Michael Woodford, 1999. "Commentary : how should monetary policy be conducted in an era of price stability?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 277-316.
  25. Sims, Christopher A, 2002. "Solving Linear Rational Expectations Models," Computational Economics, Society for Computational Economics, vol. 20(1-2), pages 1-20, October.
  26. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August.
  27. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
  28. Christopher A. Sims & Tao Zha, 2004. "Were there regime switches in U.S. monetary policy?," Working Paper 2004-14, Federal Reserve Bank of Atlanta.
  29. Giorgio Valente & Daniel Thornton & Lucio Sarno, 2005. "The Empirical Failure of the Expectations Hypothesis of the Term Structure of Bond Yields," Working Papers wp05-13, Warwick Business School, Finance Group.
  30. Boivin, Jean & Giannoni, Marc, 2006. "Has Monetary Policy Become More Effective?," CEPR Discussion Papers 5463, C.E.P.R. Discussion Papers.
  31. Alesina, Alberto & Summers, Lawrence H, 1993. "Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 25(2), pages 151-62, May.
  32. Kozicki, Sharon & Tinsley, P. A., 2001. "Shifting endpoints in the term structure of interest rates," Journal of Monetary Economics, Elsevier, vol. 47(3), pages 613-652, June.
  33. Peter Hordahl & Oreste Tristani & David Vestin, 2003. "A joint econometric model of macroeconomic and term structure," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  34. Ruge-Murcia, Francisco J., 2003. "Does the Barro-Gordon model explain the behavior of US inflation? A reexamination of the empirical evidence," Journal of Monetary Economics, Elsevier, vol. 50(6), pages 1375-1390, September.
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