Abstract
Price stability is now generally accepted as the main policy goal of monetary policy. Because the relationship between the main instrument variable used, the short-term interest rate, and the final policy goal is blurred by long and variable lags, less consensus exists regarding the question of how to use the instrument to achieve this final objective (i.e. the strategy). Friedman’s (1993, 1994) distinction between intermediate targets and information variables is useful in this respect. The intermediate targeting procedure calls for automatic changes in the instruments in reaction to unexpected movements of the variable selected as the intermediate target. The key role of the intermediate target variable is thus to provide the central bank with a ready rule for processing and acting on new information (Friedman and Kuttner, 1996). As described by Poole (1970), and elaborated by, e.g., Papademos and Modigliani (1990), the optimal choice of the intermediate target depends on the nature of disturbances influencing the economy. Possible candidates are interest rates (the stabilization of which was the central tenet of monetary policy in the Keynesian era), money supply growth (the targeting of which is central in the monetarist line of thought), the exchange rate and the expected inflation rate (in the recently developed direct inflation targeting strategy).2
Reprinted from De Economist, 146 (2), (1998), J. M. Berk, “The Information Content of the Yield Curve for Monetary Polivy: a survey”, 303–320 © 1998 with kind permission from Kluwer Academic Publishers.
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References
Svensson (1996) shows that, in contrast to what is suggested by its name, ‘direct’ inflation targeting implies inflation forecast targeting: the central bank’s inflation forcecast becomes the intermediate target.
This is not to say that these changes are the sole reason for the loss of predictive power of money. See Friedman and Kuttner (1996) for an extensive discussion.
Financial innovation led to the introduction of near monies and advanced the process of financial disintermediation (Sijben, 1995). In combination with liberalisation of international capital markets and deregulation of financial markets this created a range of new substitutes for financial assets included in the targeted monetary aggregates (Shigehara, 1996). The result was a trade-off between stability of money demand and controllability of the monetary aggregate by the central bank: the demand for broadly defined money (which is less controllable by the central bank) is more stable than the demand for narrow money. See Fase and Winder (1993) for details.
We define the term structure as the relation between the yields to maturity for different terms to maturity. Here we use the terms ‘term structure’ and ‘yield curve’ in an interchangeable fashion, which is, strictly speaking, not correct: the term structure is a particular yield curve (i.e. for zero-coupon bonds). See Shiller (1990), Svensson (1994) and Haubrich and Dombrosky (1996) for a discussion, and Deacon and Derry (1994) and Shich (1996) for details concerning the construction and estimation of various yield curves.
In addition to the yield spread as defined above, there exist other interest rate spreads which also have information content. Friedman and Kuttner (1992, 1993), for example, discuss the information content of the differential between the rate on commercial paper and the rate on Treasury Bills with regard to future inflation as well as future economic activity.
In a more general form the Fisher equation also incorporates an inflation risk premium and the conditional variance of inflation. These factors — which are quantitatively unimportant (Tzavalis and Wickens, 1996, p.105) — are omitted here for expositional ease.
For a discussion of the expectations theory. see Cox. Ingersoll and Ross (1981).
Most popular among these are the so-called uni-factor models, in which the prices of bonds of all maturities depend on a single random explanatory factor, e.g. the spot interest rate. For an example of a multi-factor model, see Brennan and Schwartz (1979).
For example, the theoretical models are formulated in continuous time. See Chan, Karolyi, Longstaff and Sanders (1992) for an empircal assessment of these models.
Mishkin interprets the real yield spread (long minus short) as the difference between longrun and short-run marginal productivity of capital. When the peak of the business cycle is reached, productive potential is fully used, short run capital productivity is high vis-à-vis capital productivity in the longer run, when activity is expected to weaken. When the trough is reached, current capital productivity is low, but the expectation of a future upswing implies h ig her long-run p roduct iv ity. Thus the real yield spread and the future bus ines s cycle are po s it ively related (Stokman,1991). An a lternat ive theoretic a l expl an ation of a (positive) relationship between the real yield spread and future real activity is presented by Harvey (1988) with the use of the CAPM. See, however, Fase (1997) for a critical discussion of the CAPM.
In this model, spending decisions are influenced by the long term rate, money market equilibrium by the short-term rate, and the long term rate by expected future short-term rates.
The analysis of fiscal shocks also becomes more complicated when price adjustments have to be taken into account. See Blanchard and Fischer (1989, p. 536) for a discussion.
This review chapter ignores the — rather complex — econometric issues involved in an empirical investigation of the information content of the yield curve (see Hansen and Hodrick, 1980, for a discussion). Therefore we neglect an important proviso that frequently emerges in the literature on the information content, namely that the results are in general very sensitive to the econometric methodology chosen to calculate the yield curve and to extract information from this curve.
It can be shown analytically, see for instance Mishkin (1990b) and Jorion and Mishkin (1991), that the information content of the yield curve is a non-linear function of (i) how variable the expected inflation change is relative to the variability of the slope of the real term structure and (ii) the correlation of the expected inflation change with the variability of the slope of the real term structure. A large variability of changes in real interest rates relative to the variability of expected inflation changes and a negative correlation between changes in the real interest rates and the expected inflation diminishes the information content with respect to future inflation changes.
As different authors study different countries which differ in data availability, sample periods analysed differ widely in the studies reviewed. For this reason, we do not report the sample periods here.
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Berk, J.M. (2001). The Information Content of the Yield Curve for Monetary Policy: A Survey. In: The Preparation of Monetary Policy. Financial and Monetary Policy Studies, vol 35. Springer, Boston, MA. https://doi.org/10.1007/978-1-4757-3405-8_2
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