IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper

Monetary policy and the term structure of interest rates in a small open economy - a model framework approach

  • Viktor Kotlán

    (Czech national bank; Faculty of Economics - VSB- TU Ostrava)

Using a simple single-equation approach, many studies have shown that the term structure of interest rates or its approximation – the term spread is a potentially useful indicator of future inflation and/or future real economic activity. We argue that these results may be biased due to the insufficiencies of the single-equation approach and that the predictive ability must be analyzed from within a model framework. Simple general equilibrium macroeconomic model of a small open economy is introduced and the indicative properties of the term structure are discussed from within its framework. Our main contribution to the literature is threefold. First, we show that the predictive ability of the term spread is not structural but monetary policy dependent. Second, we argue that the term spread's predictive ability with regard to future inflation (real economic activity) increases with increasing weight on inflation (real economic activity) stabilization in central bank's reaction function. Third, we show that undestanding the way expectations are formed is an important prerequisite for using the term structure as an indicator for monetary policy. Apart from these general findings, the predictive power of the term spread is examined in the case of the Czech economy. It is shown that the term spread between one year and three month PRIBOR interest rates of one percentage point indicates that agents expect inflation to be almost one percentage point above the target six quarters ahead.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://econwpa.repec.org/eps/mac/papers/0110/0110003.pdf
Download Restriction: no

Paper provided by EconWPA in its series Macroeconomics with number 0110003.

as
in new window

Length: 35 pages
Date of creation: 15 Oct 2001
Date of revision:
Handle: RePEc:wpa:wuwpma:0110003
Note: Type of Document - Tex; prepared on IBM PC - PC-TEX; to print on HP; pages: 35 ; figures: included. Comments welcome and encouraged
Contact details of provider: Web page: http://econwpa.repec.org

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Jim Day & Ron Lange, 1997. "The Structure of Interest Rates in Canada: Information Content about Medium-Term Inflation," Staff Working Papers 97-10, Bank of Canada.
  2. Sharon Kozicki, 1998. "Predicting inflation with the term structure spread," Research Working Paper 98-02, Federal Reserve Bank of Kansas City.
  3. Sharon Kozicki, 1997. "Predicting real growth and inflation with the yield spread," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 39-57.
  4. Piazzesi, Monika, 2001. "An Econometric Model of the Yield Curve With Macroeconomic Jump Effects," University of California at Los Angeles, Anderson Graduate School of Management qt5946p7hn, Anderson Graduate School of Management, UCLA.
  5. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
  6. Turnovsky, S.J., 1989. "The Term Structure Of Interest Rates And The Effets Of Macroeconomics Policy," Discussion Papers in Economics at the University of Washington 89-03, Department of Economics at the University of Washington.
  7. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  8. Bernanke, Ben S & Woodford, Michael, 1997. "Inflation Forecasts and Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(4), pages 653-84, November.
  9. Monika Piazzesi, 2001. "An Econometric Model of the Yield Curve with Macroeconomic Jump Effects," NBER Working Papers 8246, National Bureau of Economic Research, Inc.
  10. Estrella, Arturo & Mishkin, Frederic S., 1997. "The predictive power of the term structure of interest rates in Europe and the United States: Implications for the European Central Bank," European Economic Review, Elsevier, vol. 41(7), pages 1375-1401, July.
  11. McCallum, Bennett T & Nelson, Edward, 2001. "Monetary Policy for an Open Economy: An Alternative Framework with Optimizing Agents and Sticky Prices," CEPR Discussion Papers 2756, C.E.P.R. Discussion Papers.
  12. Svensson, L-E-O, 1996. "Inflation Forecast Targeting : Implementaing and Monitoring Inflation Targets," Papers 615, Stockholm - International Economic Studies.
  13. van Bergeijk, Peter A. G. & Berk, Jan Marc, 2000. "Is the yield curve a useful Information variable for the Eurosystem?," Working Paper Series 0011, European Central Bank.
  14. Clarida, Richard & Gali, Jordi & Gertler, Mark, 1998. "Monetary policy rules in practice Some international evidence," European Economic Review, Elsevier, vol. 42(6), pages 1033-1067, June.
  15. Arturo Estrella & Frederic S. Mishkin, 1998. "Predicting U.S. Recessions: Financial Variables As Leading Indicators," The Review of Economics and Statistics, MIT Press, vol. 80(1), pages 45-61, February.
  16. Douglas Laxton & Alasdair Scott & David Rose, 2009. "Developing a Structured Forecasting and Policy Analysis System to Support Inflation-Forecast Targeting (IFT)," IMF Working Papers 09/65, International Monetary Fund.
  17. Michael Ehrmann and Frank Smets, 2001. "Uncertain Potential Output: Implications for Monetary Policy," Computing in Economics and Finance 2001 8, Society for Computational Economics.
  18. Henri Bernard & Stefan Gerlach, 1996. "Does the term structure predict recessions? The international evidence," BIS Working Papers 37, Bank for International Settlements.
  19. Christopher Ragan, . "Deriving Agents' Inflation Forecasts from the Term Structure of Interest Rates," Staff Working Papers 95-1, Bank of Canada.
  20. Mishkin, Frederic S., 1991. "A multi-country study of the information in the shorter maturity term structure about future inflation," Journal of International Money and Finance, Elsevier, vol. 10(1), pages 2-22, March.
  21. Mishkin, Frederic S., 1990. "What does the term structure tell us about future inflation?," Journal of Monetary Economics, Elsevier, vol. 25(1), pages 77-95, January.
  22. Barry Cozier & Greg Tkacz, . "The Term Structure and Real Activity in Canada," Staff Working Papers 94-3, Bank of Canada.
  23. Carlo A. Favero, . "Does Macroeconomics Help Understand the Term Structure of Interest Rates?," Working Papers 195, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  24. Bekaert, Geert & Hodrick, Robert J. & Marshall, David A., 1997. "On biases in tests of the expectations hypothesis of the term structure of interest rates," Journal of Financial Economics, Elsevier, vol. 44(3), pages 309-348, June.
  25. N. Gregory Mankiw & Jeffrey A. Miron, 1985. "The Changing Behavior of the Term Structure of Interest Rates," NBER Working Papers 1669, National Bureau of Economic Research, Inc.
  26. Svensson, Lars E.O., 1998. "Open-Economy Inflation Targeting," Seminar Papers 638, Stockholm University, Institute for International Economic Studies.
  27. Jeffrey C. Fuhrer, 2000. "Habit Formation in Consumption and Its Implications for Monetary-Policy Models," American Economic Review, American Economic Association, vol. 90(3), pages 367-390, June.
  28. Rudebusch, Glenn D., 1995. "Federal Reserve interest rate targeting, rational expectations, and the term structure," Journal of Monetary Economics, Elsevier, vol. 35(2), pages 245-274, April.
  29. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  30. Bennett T. McCallum, 1994. "Monetary Policy and the Term Structure of Interest Rates," NBER Working Papers 4938, National Bureau of Economic Research, Inc.
  31. Francis Breedon & Jag Chadha, 1997. "The Information Content of the Inflation Term Structure," Bank of England working papers 75, Bank of England.
  32. Viktor Kotlán, 1999. "Jsou finanční indikátory schopny předpovídat vývoj ekonomické aktivity?
    [Are financial indicators capable of predicting economic activity?]
    ," Politická ekonomie, University of Economics, Prague, vol. 1999(5).
  33. Atta-Mensah, Joseph & Tkacz, Greg, 1998. "Predicting Canadian Recessions Using Financial Variables: A Probit Approach," Staff Working Papers 98-5, Bank of Canada.
  34. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
  35. Philippe Jorion & Frederic Mishkin, 1991. "A Multi-Country Comparison of Term Structure Forecasts at Long Horizons," NBER Working Papers 3574, National Bureau of Economic Research, Inc.
  36. Frederic S. Mishkin, 1989. "A Multi-Country Study of the Information in the Term Structure about Future Inflation," NBER Working Papers 3125, National Bureau of Economic Research, Inc.
  37. Smets, Frank & Tsatsaronis, Kostas, 1997. "Why Does the Yield Curve Predict Economic Activity? Dissecting the Evidence for Germany and the United States," CEPR Discussion Papers 1758, C.E.P.R. Discussion Papers.
  38. Philip Lowe & Luci Ellis, 1997. "The Smoothing of Official Interest Rates," RBA Annual Conference Volume, in: Philip Lowe (ed.), Monetary Policy and Inflation Targeting Reserve Bank of Australia.
  39. Marvin Goodfriend, 1998. "Using the term structure of interest rates for monetary policy," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 13-30.
  40. Eijffinger, Sylvester C W & Schaling, Eric & Verhagen, Willem, 2000. "The Term Structure of Interest Rates and Inflation Forecast Targeting," CEPR Discussion Papers 2375, C.E.P.R. Discussion Papers.
  41. Alexis Derviz, 1999. "Generalized Asset Return Parity and the Exchange Rate in a Finnancially open Economy," Archive of Monetary Policy Division Working Papers 1999/12, Czech National Bank.
  42. Bennett T. McCallum, 2001. "Should Monetary Policy Respond Strongly to Output Gaps?," NBER Working Papers 8226, National Bureau of Economic Research, Inc.
  43. Frederic S. Mishkin, 1990. "The Information in the Longer Maturity Term Structure about Future Inflation," The Quarterly Journal of Economics, Oxford University Press, vol. 105(3), pages 815-828.
  44. Plosser, Charles I. & Geert Rouwenhorst, K., 1994. "International term structures and real economic growth," Journal of Monetary Economics, Elsevier, vol. 33(1), pages 133-155, February.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:wpa:wuwpma:0110003. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (EconWPA)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.