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Euler equations and money market interest rates: The role of monetary and risk premium shocks

  • Gareis, Johannes
  • Mayer, Eric

This paper challenges the view that the observed negative correlation between the Federal Funds rate and the interest rate implied by consumption Euler equations is systematically linked to monetary policy. By using a Monte Carlo experiment, we show that stochastic risk premium disturbances have the capability to drive a wedge between the interest rate targeted by the central bank and the implied Euler equation interest rate such that the correlation between actual and implied rates is negative.

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File URL: http://econstor.eu/bitstream/10419/65863/1/729179907.pdf
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Paper provided by University of Würzburg, Chair for Monetary Policy and International Economics in its series W.E.P. - Würzburg Economic Papers with number 89.

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Date of creation: 2012
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Handle: RePEc:zbw:wuewep:89
Contact details of provider: Postal: Sanderring 2, D-97070 Würzburg
Phone: (0931) 31-2901
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Web page: http://www.vwl.uni-wuerzburg.de/en/no_cache/lehrstuehle/vwl1/home/
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  1. Nobuhiro Kiyotaki & John Moore, 1995. "Credit Cycles," NBER Working Papers 5083, National Bureau of Economic Research, Inc.
  2. Abel, A.B., 1990. "Asset Prices Under Habit Formation And Catching Up With The Joneses," Weiss Center Working Papers 1-90, Wharton School - Weiss Center for International Financial Research.
  3. Matteo Iacoviello & Stefano Neri, 2007. "Housing Market Spillovers: Evidence from an Estimated DSGE Model," Boston College Working Papers in Economics 659, Boston College Department of Economics, revised 23 Oct 2009.
  4. Frank Smets & Rafael Wouters, 2007. "Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach," American Economic Review, American Economic Association, vol. 97(3), pages 586-606, June.
  5. Canzoneri, Matthew B. & Cumby, Robert E. & Diba, Behzad T., 2007. "Euler equations and money market interest rates: A challenge for monetary policy models," Journal of Monetary Economics, Elsevier, vol. 54(7), pages 1863-1881, October.
  6. Richard Dennis, 2008. "Consumption-habits in a new Keynesian business cycle model," Working Paper Series 2008-35, Federal Reserve Bank of San Francisco.
  7. Matteo Iacoviello, 2002. "House prices, borrowing constraints and monetary policy in the business cycle," Boston College Working Papers in Economics 542, Boston College Department of Economics, revised 06 Dec 2004.
  8. V.V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2008. "New Keynesian Models: Not Yet Useful for Policy Analysis," NBER Working Papers 14313, National Bureau of Economic Research, Inc.
  9. Yamin Ahmad, 2004. "Money market rates and implied CCAPM rates: some international evidence," Money Macro and Finance (MMF) Research Group Conference 2003 1, Money Macro and Finance Research Group.
  10. John Y. Campbell & John H. Cochrane, 1994. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," CRSP working papers 412, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  11. Collard, Fabrice & Dellas, Harris, 2012. "Euler equations and monetary policy," Economics Letters, Elsevier, vol. 114(1), pages 1-5.
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