The term structure of CD rates and monetary policy transmission

The paper investigates the term structure of CD rates and its relationship with the federal funds rate or monetary policy. The term structure derived in this paper is governed primarily by the federal funds rate and secondarily by banks’ income smoothing behavior. It is consistent with the estimation results and differs significantly from the standard term structure of interest rates. The downturn phase of business cycles appears to be accompanied by more aggressive income smoothing by banks (compared with the upturn phase) due to their pessimistic expectations of future profits. The compositional shift in banks’ liabilities during the downturn phase away from CDs toward transaction deposits may pose a greater withdrawal risk for banks.