Shifting endpoints in the term structure of interest rates
This paper links the term structure to perceptions of monetary policy. Long-horizon forecasts of short rates needed in empirical term structure models are heavily influenced by the endpoints, or limiting conditional forecasts, of the short rate process. Mean-reversion or unit roots are commonly assumed, but do not provide realistic yield predictions. Failures occur because neither accounts for historical shifts in market perceptions of the policy target for inflation. This paper links endpoint shifts to a learning model where agents must detect shifts in long-term policy goals. With ...
Implications of rounding and rebasing for empirical analysis using consumer price inflation
Monthly CPI inflation rates can be spuriously choppy when constructed using the official CPI, rebased with 1982-84=100. The problem can be traced to rounding that occurs when only one digit after the decimal place is reported in rebased CPI data. This paper compares three CPI measures to illustrate how rounding and rebasing introduce distortions that affect variance properties, alter lag specification in autoregressive models, and "flip" results of unit root tests. To reduce distortions, the paper recommends using either original release data or the CPI rebased with 1967=100.
Predicting real growth and inflation with the yield spread
Analysts often use financial variables to help predict real activity and inflation. One of the most popular of these variables is the spread between yields on long-term and short-term government instruments, also known as the yield spread. Researchers have shown the spread is a good predictor of real activity. For instance, in a recent issue of the Economic Review, Bonser-Neal and Morley found that the spread helps predict real activity over the next year, the next two years, and the next three years.> Kozicki examines the predictive power of the yield spread for real growth and inflation in ...
Dynamic specifications in optimizing trend-deviation macro models
As noted in surveys by Goodfriend and King (1997) and Walsh (1998) and exemplified by models analyzed in Taylor (1999), there is encouraging progress in developing optimizing trend-deviation macro models that provide useful insights into the transmission and design of monetary policy. Several controversial features of a minimalist trend-deviation model, with optimizing households, firms, and bond traders, are examined. Dynamic specifications are suggested to improve the data-based realism, while preserving the simplicity, of the minimalist model.
Longer-term perspectives on the yield curve and monetary policy
In the spring of 2004, there was widespread expectation in financial markets that the Federal Reserve would shortly begin the process of raising its federal funds rate target back toward a more normal level. At the time, there was considerable concern that removing policy accommodation could lead to a sharp rise in long-term interest rates that might roil financial markets or slow the economic recovery. Much of this concern was based on the sizable increases in long-term rates that occurred when the Federal Reserve tightened policy in 1994-95 and 1999-2000. In contrast to the conventional ...
Moving endpoints and the internal consistency of agents' ex ante forecasts
Forecasts by rational agents contain embedded initial and terminal boundary conditions. Standard time series models generate two types of long-run "endpoints"--fixed endpoints and moving average endpoints. Neither can explain the shifting endpoints implied by postwar movements in the cross-section of forward rate forecasts in the term structure or by post-1979 changes in survey estimates of expected inflation. Multiperiod forecasts by a broader class of "moving endpoint" time series models provide substantially improved tracking of the historical term structure and generally support ...
What do you expect? : imperfect policy credibility and tests of the expectations hypothesis?
The expectations hypothesis is a theory of the term structure of interest rates that describes a conventional view of the transmission mechanism of monetary policy. According to the expectations hypothesis, bond rates are related to current and expected movements in the policy-controlled rate. However, empirical rejections of the expectations hypothesis are commonplace and lead many to question this description of policy transmission. This paper argues that failure to account for imperfect policy credibility may explain empirical rejections. Empirical rejections may occur even when changing ...
Term structure transmission of monetary policy
The sensitivity of bond rates to macro variables appears to vary both over time and over forecast horizons. The latter may be due to differences in forward rate term premiums and in bond trader perceptions of anticipated policy responses at different forecast horizons. Determinacy of policy transmission through bond rates requires a lower bound on the average responsiveness of term premiums and anticipated policy responses to inflation.
Why do central banks monitor so many inflation indicators?
Monetary policy is typically undertaken with an eye to achieving a select few objectives in the long run. The Federal Reserve conducts monetary policy to promote two long-run goals: price stability and sustainable economic growth. In many other countries, central banks have a single long-run goal defined in terms of an inflation target. Yet while central banks have narrowly defined long-run goals, most monitor a wide range of economic indicators.> Why do central banks collect and analyze so many indicators? Kozicki presents multicountry empirical evidence to assess whether any single ...
Estimating forward-looking Euler equations - discussion