Equilibrium Yield Curves and the Interest Rate Lower Bound

65 Pages Posted: 8 Nov 2016

See all articles by Taisuke Nakata

Taisuke Nakata

Board of Governors of the Federal Reserve System

Hiroatsu Tanaka

Board of Governors of the Federal Reserve System

Date Written: 2016-10

Abstract

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. The ELB constraint induces state-dependency in the dynamics of term premiums by affecting macroeconomic uncertainty and interest-rate sensitivity to economic activities. In a model calibrated to match key features of the aggregate economy and term structure dynamics in the U.S. above and at the ELB, we find that the ELB constraint typically lowers the absolute size of term premiums at the ELB and increases their volatility around the time of liftoff. 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.

Keywords: Effective Lower Bound, Forward Guidance, New Keynesian Model, Recursive Preference, Term Premiums, Term Structure of Interest Rates, Yield Curves

JEL Classification: E12, E32, E43, E44, E52, G12

Suggested Citation

Nakata, Taisuke and Tanaka, Hiroatsu, Equilibrium Yield Curves and the Interest Rate Lower Bound (2016-10). FEDS Working Paper No. 2016-085. Available at SSRN: https://ssrn.com/abstract=2866265 or http://dx.doi.org/10.17016/FEDS.2016.085

Taisuke Nakata

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Hiroatsu Tanaka (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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