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Lowering the Anchor
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Excess Sensitivity and Volatility of Long Interest Rates
Asymmetric information between the central bank and bond markets creates an inference problem that affects the behaviour of long interest rates. This paper employs a simple macroeconomic model with a time-varying inflation target to illustrate the implications of asymmetry for the sensitivity of long rates and volatility of bond returns. When the central bank's inflation target is not communicated and macroeconomic shocks are imperfectly observed, bond markets infer the value of the target from noisy signals. This heightens the sensitivity of long-run inflation expectations to transitory shocks, thereby raising the measured reaction of long rates to monetary policy and to inflation surprises. Calibrated coeffcients from such regressions are more than twice as large when bondmarkets lack knowledge of the target compared with a full information scenario. Time variation in the inflation target is the main source of volatility, but learning adds to the ability of the model to explain the observed volatility of returns along the yield curve.
Testing the Expectations Hypothesis when Interest Rates are Near Integrated
"Nominal interest rates are unlikely to be generated by unit-root processes. Using data on short and long interest rates from eight developed and six emerging economies, we test the expectations hypothesis using cointegration methods under the assumption that interest rates are near integrated. If the null hypothesis of no cointegration is rejected, we then test whether the estimated cointegrating vector is consistent with that suggested by the expectations hypothesis. The results show support for cointegration in ten of the fourteen countries we consider, and the cointegrating vector is similar across countries. However, the parameters differ from those suggested by theory. We relate our findings to existing literature on the failure of the expectations hypothesis and to the role of term premia"--Federal Reserve Board web site.
Central Bank Forecasts of Policy Interest Rates
In recent years, the central banks of Norway and Sweden have published their endogenous policy interest-rate forecasts. In this paper, we evaluate those forecasts alongside policy-rate expectations inferred from market pricing. We find that for both economies, there are only small differences in relative forecasting precision between the central bank and market-implied measures. However, both types of forecast fail tests for unbiasedness and efficiency at longer horizons.
A Bayesian Vector Autoregressive Model with Informative Steady-State Priors for the Australian Economy
This article applies a Bayesian vector autoregressive model with informative steady-state priors to a parsimonious model of the Australian economy. The model captures economic linkages among key Australian and US variables and is estimated on quarterly data from 1985 to 2006. An out-of-sample forecast exercise shows that the model with informative steady-state priors generally outperforms a traditional Bayesian vector autoregressive model as well as naïve forecasts. The model can also be used to generate density forecasts and analyse alternative scenarios, which we illustrate with the effect on the Australian economy of a substantial real depreciation of the US dollar.
Financial Innovation
Prominent economists consider the role of financial innovation in economic crises.
