Abstract
It is a widely accepted consensus that the operating instrument with which a central bank conducts monetary policy is the short-term interest rate. Typically, it sets its policy rate conditional on the macroeconomic environment for the purpose of achieving its final goals of price stability as well as output stability. Managing aggregate demand operates through various transmission channels where interest rate moves affect the whole set of asset prices, the net worth of balance sheet positions and the lending behavior of banks. An important feature in the traditional interest-rate channel is the emphasis on real rather than nominal interest rates and the role of long-term interest rates.
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Notes
- 1.
See Allsopp and Vines (2000) for an early assessment of the consensus view and Woodford (2003) for a rigoros microeconomic approach to macroeconomic policy analysis.
- 2.
See Chap. 3.5.2 in this work. As described there, term premia estimates are subject to considerable uncertainties surrounding the estimation procedure and the structural specifications of term structure models.
- 3.
Extensive literature elaborates on the effectiveness of monetary policy and the role of expected future interest rates. A selected collection is Goodfriend (1991), Rudebusch (1995) and Woodford (1999b).
- 4.
See Trichet (2009) for a treatment from a policymaker’s view.
- 5.
It is in this context why central bankers do not stop highlighting that the decision-making body never precommits.
- 6.
For an empirical application on the futures market see Piazzesi and Swanson (2008) for federal funds futures and Joyce et al. (2009b) for the BoE’s bank rate
- 7.
See Estrella and Mishkin (1997), Hamilton and Kim (2002), Stock and Watson (2003a), Favero et al. (2005) or Ang et al. (2006) among many others.
- 8.
See e.g. Kohn (2005) or Bernanke (2006). Kohn notes that “[..] the decline in term premiums in the Treasury market of late may have contributed to keeping long-term interest rates relatively low and, consequently, may have supported the housing sector and consumer spending more generally.” On the contrary, a bulk of evidence suggest that term premia and output growth are positively correlated (Hamilton and Kim, 2002; Favero et al., 2005).
- 9.
See Chap. 6.4 on the decomposition of the nominal yield curve.
- 10.
See for instance for the US Gürkaynak et al. (2005b), Peersman (2002) or Beechey (2006). For the euro area, results are rather mixed. Empirical evidence suggests that far distant forward rates do not respond much to macroeconomic events (Ehrmann et al., 2007).
- 11.
See Mehra (2001), Gerlach-Kristen (2003), Fendel and Frenkel (2005) and Vázquez (2009).
- 12.
Clarida et al. (2000) estimate forward-looking Taylor rules that incorporate Feds expectations of these variables as rational ones and hence, they reflect t − 1 period information known to the Fed. Expected variables are replaced by their realized counterparts.
- 13.
See Appendix C for a derivation.
- 14.
See for example Estrella and Mishkin (1997), Evans and Marshall (1998), Kozicki and Tinsley (2001), Wu (2003), Marzo et al. (2008).
- 15.
Notice, that in the following Section, the term “structural” and/or “restricted” does not refer to the econometric use of the words concerning model identification. They are mainly used to describe macro-finance models in terms of their structure and their cross-restriction properties between different bond prices.
- 16.
See Evans and Marshall (1998) or Estrella and Hardouvelis (1991).
- 17.
See Chap. 3.5.2 for a discussion on the stochastic discount factor and market prices of risk.
- 18.
Bernanke and Reinhart (2004), Fendel (2004), Bundesbank (2006), Dewachter and Lyrio (2006), Bolder (2006), Ang et al. (2007), Lildholdt et al. (2007), Chernov and Mueller (2008), Pericoli and Taboga (2008).
- 19.
See Hördahl et al. (2006), Hördahl and Tristiani (2007), Lemke (2008), Rudebusch and Wu (2008).
- 20.
The general equilibrium models in the spirit of Lucas (1978) usually have simplified the economy by assuming exogenous processes for consumption, dividend growth or trivial production sectors. For an overview see Jermann (1998).
- 21.
In contrast to the standard New-Keynesian textbook model, DSGE models cover a more detailed view on the economy. Following Smets and Wouters (2003), households consume, decide how much to invest (asset purchases to transfer wealth) and are monopolistic suppliers of differentiated types of labor, which allow them to set wages. In turn, firms hire labor, rent capital and are monopolistic suppliers of differentiated goods which allows them to set prices. Both agents are confronted by a large number of nominal frictions which constrain their ability to reset prices or wages. On the real side, capital is accumulated in an endogenous manner and there are real rigidities arising from adjustment costs to investment or fixed costs. Households preferences display habit persistence in consumption, and the utility function is separable in terms of consumption, leisure and real money balances. Fiscal policy is usually supposed to work in a Ricardian setting, while monetary policy is conducted through a Taylor-type reaction function, in which the interest rate is set in response to deviations from an inflation target and some measure of economic activity. More recently, these models have been extended by including financial markets in particular financial frictions into the set up (Goodfriend and McCallum, 2007; Canzoneri et al., 2008; Cúrdia and Woodford, 2008).
- 22.
Whether DSGE models are truly micro-founded or not is a matter of current debate. Critiques claim that these foundations are rather ad-hoc than economically justified neither from an empirical nor from an intuitive plausible perspective. The assumption of the representative agent who acts as a superior statistician defines away important challenges in macro theory such as coordination problems, interactions between heterogenous agents, learning aspects and imperfect markets (Spahn, 2009; Colander et al., 2008). A defence in favor of DSGE models is that research has begun to incorporate the presence of heterogenous agents in a learning environment, imperfect credit markets, income constrained households in the spirit of Keynes, non-Ricardian fiscal policy regimes or the possibility of default (Goodhart et al., 2006; DeGraeve et al., 2008; Rattoa et al., 2008; Annicchiarico et al., 2009; Fiore and Tristani, 2009). Obviously, this comes at the cost of larger models.
- 23.
See Ravenna and Seppl (2006); DePaoli et al. (2007); Rudebusch and Swanson (2008a,b); Hördahl et al. (2008).
- 24.
This approach was suggested by Jermann (1998) and applied by Wu (2006); Emiris (2006); DeGraeve et al. (2009); Bekaert et al. (2010).
- 25.
A textbook treatment of a reduced-form NK-model with investment as represented by Tobin’s Q in the aggregate demand equation can be found in Gali and Gertler (2007).
- 26.
The notation of nominal bond holdings is such that each period a bond becomes a one-period bond and is, thus, not available anymore in the next period to form the portfolio.
- 27.
Most recently, McCallum (2009) elaborates the interconnection between determinacy and learnability of economic systems. Determinacy, as defined by the existence of a single RE solution, is neither sufficient nor necessary for the stable evolution of market processes. The central task to work on is the examination of whether the model is learnable. Though a model may posses more than one stable solution, the criteria of learnability allows to pin down the only one solution that “[..] could prevail in practice” McCallum (2009, 10).
- 28.
See Sack (1998), Bullard and Mitra (2002), Locarno (2006), Bullard (2006), Evans and Honkapohja (2003), Evans and Honkapohja (2006), Evans and Honkapohja (2008).
- 29.
Sunspots occur whenever the market process depends on extraneous random variables that influence the economy solely through the expectations of the agents.
- 30.
See Bullard and Eusepi (2005), Sargent et al. (2006), Sargent et al. (2009), Orphanides and Williams (2005b), Milani (2007), Eusepi and Preston (2008).
- 31.
Alternatively, one could assume that the state variables in Xtare not included in the information set at period tso that expectations are formed with an information set up to t − 1.
- 32.
This stark assumption can be macerated by treating the times series process of the shock process as unknown, too. This would end up in a unrestricted forecasting VAR with little economic structure.
- 33.
For that reason, Orphanides and Williams (2005a) characterize the learning algorithm as perpetual.
- 34.
Evans and Honkapohja (2001), Orphanides and Williams (2006), Gaspar et al. (2006), Carceles-Poveda and Giannitsarou (2007).
- 35.
In simulation, the projection facility constraint applies in less than 2% of total simulation periods, so it is rather rare.
- 36.
See Appendix C for a derivation of this result.
- 37.
The closest work is Laubach et al. (2007) who allows time variation of the whole parameter set, but they do not impose any economic structure.
- 38.
Moreover, notice that we describe de-meaned dynamics and since the NK-Model only works with constant risk premia they should stay constant over time.
- 39.
In the macro-finance literature, shocks to natural output are often quantitatively captured by a quarterly standard deviation of over 2% points or the natural rate process and the inflation target are near-random walks that mechanically produce high persistence. In the model above, standard deviations of shocks are in the range found in empirical estimates and the processes of natural output and the inflation target are persistent, though they do not follow near random walks (Ravenna and Seppl, 2006; Rudebusch and Swanson, 2008b; Hördahl and Tristiani, 2007).
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Geiger, F. (2011). The Macro-Finance View of the Term Structure of Interest Rates. In: The Yield Curve and Financial Risk Premia. Lecture Notes in Economics and Mathematical Systems, vol 654. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-642-21575-9_5
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