Real and Nominal Equilibrium Yield Curves with Endogenous Inflation: A Quantitative Assessment

Abstract

The links between real and nominal bond risk premia and macroeconomic dynamics are explored analytically and quantitatively in a model with nominal rigidities and monetary policy. The interest-rate policy rule becomes a restriction linking real and nominal risk premia through endogenous inflation. The estimated model captures macroeconomic and yield curve properties of the U.S. economy, implying significantly positive real term and inflation risk bond premia. Both premia are induced by wage rigidities as a compensation for permanent productivity shocks. Stronger policy-rule responses to inflation (output) increase (decrease) both premia. Policy surprises generate significant yield volatility but negligible risk premia.

Keywords: Term structure of interest rates, bond risk premia, monetary policy, nominal rigidities

JEL Classification: D51, E43, E44, E52, G12