Equilibrium Growth, Inflation, and Bond Yields
50 Pages Posted: 1 Mar 2012 Last revised: 4 Jun 2012
Date Written: June 1, 2012
This paper explores bond pricing implications of a stochastic endogenous growth model with imperfect price adjustment. In this setting, the production and price-setting decisions of firms drive low-frequency movements in macro growth and inflation rates that are negatively related, as in the data. With recursive preferences, these endogenous long-run growth and inflation dynamics are crucial for explaining a number of stylized facts in bond markets. Notably, when calibrated to a wide range of macroeconomic data, the model quantitatively explains the means and volatilities of nominal bond yields. The model also generates a sizeable equity premium and high investment volatility.
Keywords: Term structure of interest rates, asset pricing, recursive preferences, monetary policy, endogenous growth, inflation, productivity.
JEL Classification: E43, E44, G12, G18
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