English, Article, Journal or magazine article edition: Monetary Policy and the Term Structure of Interest Rates University of California; University of Illinois; Juha Seppala; ...

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Physical Description
  • preprint
Language
  • English

Edition details

Title
  • Monetary Policy and the Term Structure of Interest Rates
Author
  • University of California
  • University of Illinois
  • Juha Seppala
  • Federico Ravenna
Physical Description
  • preprint
Notes
  • 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.
  • Term Structure of Interest Rates, Monetary Policy, Sticky Prices, Habit Persistence, Expectations Hypothesis.
  • RePEc:sce:scecfa:197
  • Term Structure of Interest Rates, Monetary Policy, Sticky Prices, Habit Formation, Expectations Hypothesis
  • RePEc:red:sed005:804
Language
  • English
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