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The relative importance of Term Spread, Policy Inertia and Persistent Monetary Policy Shocks in Monetary Policy Rules

  • Ramón Maria-Dolores
  • Jesus Vazquez

This paper estimates a standard version of the New Keynesian Monetary Model (NKM) augmented with the term structure in order to analyze two types of issue. First we analyse the relative importance of policy inertia, persistent policy shocks and the term spread in the estimated US monetary policy rule. Second, we study the ability of the model to reproduce some stylized facts such as high persistent dynamics and the weak comovement between economic activity and inflation observed in actual US data. The estimation procedure implemented is a classical structural method based on the indirect inference principle. The empirical results show that (i) policy intertia, persistent policy shocks and the term spread are all significant determinants in the estimated US monetary policy rule, (ii) the Fed responds to the information content of the spread about future inflation and real activity, but the Fed does not seem to respond independently to the spread; and (iii) the model augmented with term structure reproduces the weak comovement between economic activity and inflation as well as the strong comovement at medium and long-term forecast horizons between the Fed rate and the 1-yar rate observed in the US dat

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2006 with number 6.

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Date of creation: 04 Jul 2006
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Handle: RePEc:sce:scecfa:6
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