The response of term rates to monetary policy uncertainty |
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Authors: |
scar Jord Kevin D Salyer |
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Institution: | Department of Economics, U.C. Davis, One Shields Ave., Davis, CA 95616-8578, USA |
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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. |
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Keywords: | Limited participation Term structure Mean preserving spread Multivariate GARCH GARCH-SVAR |
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