Equilibrium Yield Curves and the Interest Rate Lower Bound

05 October 2016
12:30  - 13:30

Hiroatsu Tanaka, FED



We study the term structure of default-free interest rates in a sticky-price model with an occasionally binding effective lower bound (ELB) constraint on interest rates and recursive preferences. Our model is calibrated to match key features of term structure dynamics in the U.S. above and at the ELB. The ELB constraint induces state-dependency in the dynamics of term premiums, typically lowering the absolute size of term premiums at the ELB and increasing their volatility around the time of liftoff. We find that the central bank’s announcement to keep the policy rate at the ELB for longer than previously expected lowers the expected short rate path, but its effect on term premiums depends on the risk exposure of bonds to the macroeconomy; while the announcement increases term premiums if bonds are a hedge against economic downturns, it decreases them otherwise.

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