Switching monetary policy regimes and the nominal term structure

Marcelo Ferman

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: In this paper I propose a regime-switching approach to explain why the U.S. nominal yield curve on average has been steeper since the mid-1980s than during the Great Inflation of the 1970s. I show that, once the possibility of regime switches in the short-rate process is incorporated into investors' beliefs, the average slope of the yield curve generally will contain a new component called 'level risk'. Level-risk estimates, based on a Markov-Switching VAR model of the U.S. economy, are then provided. I find that the level risk was large and negative during the Great Inflation, reflecting a possible switch to lower short-rate levels in the future. Since the mid-1980s the level risk has been moderate and positive, reflecting a small but still relevant possibility of a return to the regime of the 1970s. I replicate these results in a Markov-Switching dynamic general equilibrium model, where the monetary policy rule followed by the Fed shifts between an active and a passive regime. The model also explains why in recent decades the U.S. yield curve on average has been steeper than the yield curve in countries that adopted explicit inflation targeting frameworks.

JEL-codes: E42 E43 E44 E52 E58 (search for similar items in EconPapers)
Pages: 51 pages
Date: 2011-04-01
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://eprints.lse.ac.uk/119070/ Open access version. (application/pdf)

Related works:
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:ehl:lserod:119070

Access Statistics for this paper

More papers in LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library LSE Library Portugal Street London, WC2A 2HD, U.K.. Contact information at EDIRC.
Bibliographic data for series maintained by LSERO Manager ().