Term Structure Evidence on Interest Rate Smoothing and Monetary Policy Inertia

Abstract

Numerous studies have used quarterly data to estimate monetary policy rules or reaction functions that appear to exhibit a very slow partial adjustment of the policy interest rate. The conventional wisdom asserts that this gradual adjustment reßects a policy inertia or interest rate smoothing behavior by central banks. However, such quarterly monetary policy inertia would imply a large amount of forecastable variation in interest rates at horizons of more than three months, which is contradicted by evidence from the term structure of interest rates. The illusion of monetary policy inertia evident in the estimated policy rules likely reßects the persistent shocks that central banks face. JEL classiÞcation: E4; E5

Term structure modelling with observable state variables

“…This momentum in the literature is partly due to the fact that 'yields-only' models based on no-arbitrage were found to do well in fitting the cross-section of yields at a particular point in time (Dai and Singleton, 2000), but poorly in describing the dynamics of the yield curve (Duffee, 2002). Contributions to the literature include Fuhrer and Moore (1995), Rudebusch (1995Rudebusch ( , 2002, Evans and Marshall (1996), Fuhrer (1996), Ang and Piazzesi (2003), Bikbov and Chernov (2010), Piazzesi (2005), Dewachter and Lyrio (2006), Hördahl et al (2006), and Rudebusch and Wu (2008).…”

News on inflation and the epidemiology of inflation expectations in China

“…In response to this question, a number of important studies have emphasized the use of survey-based inflation expectations instead of rational expectations approximation in the relevant analyses since the 1990s (e.g. Roberts, 1995;Thomas, 1999;Rudebusch, 2002;Orphanides, 2003;Ang et. al.，2007).…”

Tests of the expectations hypothesis: Resolving the anomalies when the short-term rate is the federal funds rate

“…These results do suggest, however, that there are factors, other than the marketÕs expectation for the effective federal funds rate, that determine the T-bill rate. That the marketÕs expectation for the short-term rate is not the sole determinant of the long-term rate is perhaps not too surprising in light of evidence on the difficulty of predicting interest rates (e.g., Rudebusch, 2002;Poole et al, 2002;Diebold and Li, 2003;Duffee, 2002).…”