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Monetary Policy Uncertainty and the Response of the Yield Curve to Policy Shocks

Author

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  • Peter Tillmann

    () (Justus-Liebig-University Giessen)

Abstract

This paper studies the non-linear response of the term structure of interest rates to monetary policy shocks. We show that uncertainty about monetary policy changes the way the term structure responds to monetary policy. A policy tightening leads to a significantly smaller increase in long-term bond yields if policy uncertainty is high at the time of the shock. We also look at the decomposition of bond yields into expectations about policy and the term premium. The weaker response of yields is driven by the fall in term premia, which fall even more if uncertainty about policy is high. These findings are robust to the measurement of monetary policy uncertainty and the definition of the monetary policy shock. We argue that short-term uncertainty about monetary policy tends to make yields of longer maturities relatively more attractive. As a consequence, investors demand lower term premia. This intuition is supported by the fact that long-term monetary policy uncertainty leads to opposite effects with term premia increasing even more after a policy shock.

Suggested Citation

  • Peter Tillmann, 2017. "Monetary Policy Uncertainty and the Response of the Yield Curve to Policy Shocks," MAGKS Papers on Economics 201724, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
  • Handle: RePEc:mar:magkse:201724
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    File URL: https://www.uni-marburg.de/fb02/makro/forschung/magkspapers/paper_2017/24-2017_tillmann.pdf
    File Function: First 201724
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    Cited by:

    1. Efrem Castelnuovo & Giovanni Pellegrino, 2018. "Uncertainty-dependent Effects of Monetary Policy Shocks: A New Keynesian Interpretation," "Marco Fanno" Working Papers 0219, Dipartimento di Scienze Economiche "Marco Fanno".
    2. Efrem Castelnuovo & Giovanni Pellegrino, 2017. "Uncertainty-dependent Effects of Monetary Policy Shocks: A New Keynesian Interpretation," CESifo Working Paper Series 6821, CESifo Group Munich.

    More about this item

    Keywords

    Monetary policy uncertainty; term structure; term premium; unconventional monetary policy; local projections;

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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