A Macroeconomic Approach to the Term Premium

Emanuel Kopp and Peter Williams

No 2018/140, IMF Working Papers from International Monetary Fund

Abstract: In recent years, term premia have been very low and sometimes even negative. Now, with the United States economy growing above potential, inflationary pressures are on the rise. Term premia are very sensitive to the expected future path of growth, inflation, and monetary policy, and an inflation surprise could require monetary policy to tighten faster than anticipated, inducing to a sudden decompression of term and other risk premia, thus tightening financial conditions. This paper proposes a semi-structural dynamic term structure model augmented with macroeconomic factors to include cyclical dynamics with a focus on medium- to long-run forecasts. Our results clearly show that a macroeconomic approach is warranted: While term premium estimates are in line with those from other studies, we provide (i) plausible, stable estimates of expected long-term interest rates and (ii) forecasts of short- and long-term interest rates as well as cyclical macroeconomic variables that are stunningly close to those generated from large-scale macroeconomic models.

Keywords: WP; term structure of interest rates; term premium; yield curve; State Space; inflation expectation; New York Fed conduct; risk-free rate; core PCE inflation series; interest rate forecast; interest rate expectation; hike cycle; inflation variable; Inflation; Short term interest rates; Bonds; Unemployment (search for similar items in EconPapers)
Pages: 22
Date: 2018-06-15
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Citations: View citations in EconPapers (6)

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