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The Role of Monetary Policy Uncertainty in the Term Structure of Interest Rates

  • Junko Koeda

    (Assistant Professor, Department of Economics, University of Tokyo, 7-3-1, Hongo, Bunkyo-ku, Tokyo, Japan. Tel: +81-3- 5841-5649, (E-mail:

  • Ryo Kato

    (Director and Senior Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail:

We examine the effect of uncertainty arising from policy-shock volatility on yield-curve dynamics. In contrast to the assumption of many macro-finance models, policy-shock processes appear to be time varying and persistent. We allow for this heteroskedasticity by constructing a no-arbitrage GARCH affine term structure model, in which policy-shock volatility is defined as the conditional volatility of the error term in a Taylor rule. We find that an increase in monetary policy uncertainty raises the medium- and longer-term spreads in a model that incorporates macroeconomic dynamics.

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Paper provided by Institute for Monetary and Economic Studies, Bank of Japan in its series IMES Discussion Paper Series with number 10-E-24.

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Date of creation: Oct 2010
Date of revision:
Handle: RePEc:ime:imedps:10-e-24
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  1. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  2. Kuttner, Kenneth N., 2001. "Monetary policy surprises and interest rates: Evidence from the Fed funds futures market," Journal of Monetary Economics, Elsevier, vol. 47(3), pages 523-544, June.
  3. Glenn D. Rudebusch & Tao Wu, 2007. "Accounting for a Shift in Term Structure Behavior with No-Arbitrage and Macro-Finance Models," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(2-3), pages 395-422, 03.
  4. Andrew Ang & Monika Piazzesi & Min Wei, 2003. "What does the yield curve tell us about GDP growth?," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  5. Favero, Carlo A. & Mosca, Federico, 2001. "Uncertainty on Monetary Policy and the Expectational Model of the Term Structure of Interest Rates," CEPR Discussion Papers 2748, C.E.P.R. Discussion Papers.
  6. Glenn D. Rudebusch & Eric T. Swanson & Tao Wu, 2006. "The Bond Yield "Conundrum" from a Macro-Finance Perspective," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 24(S1), pages 83-109, December.
  7. Tao Wu & Glenn Rudebusch, 2004. "A Macro-Finance Model of the Term Structure, Monetary Policy, and the Economy," 2004 Meeting Papers 104, Society for Economic Dynamics.
  8. Glenn D. Rudebusch, 2001. "Term structure evidence on interest rate smoothing and monetary policy inertia," Working Paper Series 2001-02, Federal Reserve Bank of San Francisco.
  9. Brenner, Robin J. & Harjes, Richard H. & Kroner, Kenneth F., 1996. "Another Look at Models of the Short-Term Interest Rate," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 31(01), pages 85-107, March.
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