Monetary Policy and the Term Structure of Interest Rates

Federico Ravenna, University of California, Juha Seppala () and University of Illinois

No 197, Computing in Economics and Finance 2006 from Society for Computational Economics

Abstract: We study how well a New Keynesian business cycle model can explain the observed behavior of nominal interest rates. We focus on two puzzles raised in previous literature. First, Donaldson, Johnsen, and Mehra (1990) show that while in the U.S. nominal term structure the interest rates are pro-cyclical and term spreads counter-cyclical the stochastic growth model predicts that the interest rates are counter-cyclical and term spreads pro-cyclical. Second, according to Backus, Gregory, and Zin (1989) the standard general equilibrium asset pricing model can account for neither the sign nor the magnitude of average risk premiums in forward prices. Hence, the standard model is unable to explain rejections of the expectations hypothesis. We show that a New Keynesian model with habit-persistent preferences and a monetary policy feedback rule produces pro-cyclical interest rates, counter-cyclical term spreads, and creates enough volatility in the risk premium to account for the rejections of expectations hypothesis. Moreover, unlike Buraschi and Jiltsov (2005), we identify the systematic monetary policy, not monetary policy shocks, as the key factor behind rejections of expectations hypothesis.

Keywords: Term Structure of Interest Rates; Monetary Policy; Sticky Prices; Habit Persistence; Expectations Hypothesis. (search for similar items in EconPapers)
JEL-codes: E43 E52 G12 (search for similar items in EconPapers)
Date: 2006-07-04
New Economics Papers: this item is included in nep-cba, nep-fin, nep-mac and nep-mon
References: Add references at CitEc
Citations: View citations in EconPapers (8)

Downloads: (external link)
http://www.business.uiuc.edu/seppala/research/#mopo main text (text/plain)
Our link check indicates that this URL is bad, the error code is: 500 Can't connect to www.business.uiuc.edu:80 (No such host is known. )

Related works:
Working Paper: Monetary Policy and the Term Structure of Interest Rates (2005)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:sce:scecfa:197

Access Statistics for this paper

More papers in Computing in Economics and Finance 2006 from Society for Computational Economics Contact information at EDIRC.
Bibliographic data for series maintained by Christopher F. Baum ().