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Level and Volatility Shocks to Fiscal Policy: Term Structure Implications

Listed author(s):
  • Lorenzo Bretscher

    (London School of Economics)

  • Alex Hsu

    (Georgia Institute of Technology)

  • Andrea Tamoni

    (London School of Economics)

Registered author(s):

    We estimate a New-Keynesian model with heterogeneous agents to study the impact of level and volatility shocks to fiscal policy on the term structure of interest rates and bond risk premia. We derive three key insights from the theoretical model. First, government spending level shocks generate positive covariance between marginal utility to consume and inflation, making nominal bonds poor hedges against consumption risk and result in positive risk premium. Second, variability in the nominal term premium is caused by variation in the real term premium while inflation risk premium is remarkably stable over time. Fluctuation of the real term premium is entirely driven by government spending volatility shocks. Third, at the zero lower bound (ZLB), impact of level and volatility shocks to government spending are amplified. This is especially pronounced for volatility shocks producing substantial bond risk premium when the ZLB is binding.

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    File URL: https://economicdynamics.org/meetpapers/2017/paper_258.pdf
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    Paper provided by Society for Economic Dynamics in its series 2017 Meeting Papers with number 258.

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    Date of creation: 2017
    Handle: RePEc:red:sed017:258
    Contact details of provider: Postal:
    Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

    Web page: http://www.EconomicDynamics.org/
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