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Federal Reserve Bank of Kansas City
Research Working Paper
Forward Guidance, Monetary Policy Uncertainty, and the Term Premium
Brent Bundick
Trenton Herriford
Andrew Lee Smith
Abstract

We examine the macroeconomic and term-premia implications of monetary policy uncertainty shocks. Using Eurodollar options, we employ the VIX methodology to measure implied volatility about future short-term interest rates at various horizons. We identify monetary policy uncertainty shocks using the unexpected changes in this term structure of implied volatility around monetary policy announcements.

Two principal components succinctly characterize these changes around policy announcements, which have the interpretation as shocks to the level and slope of the term structure of implied interest rate volatility. We find that an unexpected decline in the slope of implied volatility lowers term premia in longer-term bond yields and leads to higher economic activity and inflation.

Our results suggest that forward guidance about future monetary policy can materially affect bond market term premia, even without large-scale asset purchases.


Download https://doi.org/10.18651/RWP2017-07
Cite this item
Brent Bundick & Trenton Herriford & Andrew Lee Smith, Forward Guidance, Monetary Policy Uncertainty, and the Term Premium, Federal Reserve Bank of Kansas City, Research Working Paper RWP 17-7, 12 Jul 2017.
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Keywords: Monetary policy; Bond Forward Guidance; Policy Uncertainty; Term Premium
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