Monetary Policy Shifts and Long-Term Interest Rates

The Pure Expectations Hypothesis (PEH) serves as the benchmark model for the relationship between yields on bonds of different maturities. When coupled with rational expectations, however, empirical renderings of the model fail miserably. I explore the possibility that failure to account for changes...

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Bibliographic Details
Published in:The Quarterly journal of economics 1996-11, Vol.111 (4), p.1183-1209
Main Author: Fuhrer, Jeffrey C.
Format: Article
Language:English
Subjects:
Bonds
Coefficients
Economic expectations
Economic models
Economic theory
Federal funds rate
Federal Reserve Bank
Financial instruments
Hypotheses
Inflation rates
Interest rates
Mathematical independent variables
Monetary policy
Monetary theory
Rational expectations
Studies
Vector autoregression
Yield to maturity
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Summary:The Pure Expectations Hypothesis (PEH) serves as the benchmark model for the relationship between yields on bonds of different maturities. When coupled with rational expectations, however, empirical renderings of the model fail miserably. I explore the possibility that failure to account for changes in monetary policy regime explains much of the failure of the PEH. Estimating changing monetary regimes in conjunction with the PEH significantly improves its performance. The predicted spread between the long and short rates is highly correlated with the actual spread. The standard deviation of the theoretical spread is nearly identical to that of the actual spread.
ISSN:0033-5533
1531-4650
DOI:10.2307/2946712