Level and Volatility Shocks to Fiscal Policy: Term Structure Implications
83 Pages Posted: 15 Sep 2016 Last revised: 5 Nov 2017
Date Written: November 4, 2017
We study the impact of fiscal policy shocks on bond risk premia. Government spending level shocks generate positive covariance between marginal utility and inflation (term structure level effect) making nominal bonds a poor hedge against consumption risk leading to positive inflation risk premia. Volatility shocks to spending have strong slope effect (steepening) on the yield curve, producing positive nominal term premia. For level and volatility shocks to capital income tax, term structure level effects dominate, delivering negative risk premia. Fluctuations in term premia are entirely driven by volatility shocks. Lastly, fiscal shocks are amplified at the zero lower bound.
Keywords: Term structure, Bond Risk Premia, Uncertainty, Fiscal Policy
JEL Classification: E62, G12
Suggested Citation: Suggested Citation