The Response of Term Rates to Monetary Policy Uncertainty

Oscar Jorda () and Kevin Salyer ()

Review of Economic Dynamics, 2003, vol. 6, issue 4, pages 941-962

Abstract: This paper shows that greater uncertainty about monetary policy can lead to a decline in nominal interest rates. In the context of a limited participation model, monetary policy uncertainty is modeled as a mean preserving spread in the distribution for the money growth process. This increase in uncertainty lowers the yield on short-term maturity bonds because the household sector responds by increasing liquidity in the banking sector. Long-term maturity bonds also have lower yields but this decrease is a result of the effect that greater uncertainty has on the nominal intertemporal rate of substitution––which is a convex function of money growth. We examine the nature of these relations empirically by introducing the GARCH-SVAR model––a multivariate generalization of the GARCH-M model. The predictions of the model are broadly supported by the data: higher uncertainty in the federal funds rate can lower the yields of the three- and six-month treasury bill rates. (Copyright: Elsevier)

Keywords: Limited participation; Term structure; Mean preserving spread; Multivariate GARCH; GARCH-SVAR (search for similar items in EconPapers)
JEL-codes: E4 E5 C4 (search for similar items in EconPapers)
Date: 2003
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Working Paper: The Response of Term Rates to Monetary Policy Uncertainty (2001)
Working Paper: The Response of Term Rates to Monetary Policy Uncertainty
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