Evidence Uncovered: Long-Term Interest Rates, Monetary Policy, And the Expectations Theory

51 Pages Posted: 6 Nov 2001

See all articles by Jennifer E. Roush

Jennifer E. Roush

Board of Governors of the Federal Reserve System

Date Written: October 2001

Abstract

A large body of literature has failed to find conclusive evidence that the expectations theory of the term structure holds in U.S. data. This paper asks more narrowly whether the theory holds conditional on an exogenous change in monetary policy. We argue that previous work on the expectation theory has failed to sufficiently account for interactions between monetary policy and bond markets in the determination of long and short interest rates. Using methods that directly account for this interaction, we find strong evidence supporting a term structure channel for policy that is consistent with the expectations theory. We show that the marginal effect of our consideration for this source of simultaneity bias is significant in uncovering evidence for the theory. We also discuss previous claims that policy regime changes and short-term interest rate smoothing by the Fed accounts for the theory's unconditional failure in light of our findings.

Keywords: term structure, vector autoregression, interest rate smoothing, policy regimes, Bayesian VAR

JEL Classification: C11, C32, E43, E44, E52

Suggested Citation

Roush, Jennifer E., Evidence Uncovered: Long-Term Interest Rates, Monetary Policy, And the Expectations Theory (October 2001). Available at SSRN: https://ssrn.com/abstract=289340 or http://dx.doi.org/10.2139/ssrn.289340

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Board of Governors of the Federal Reserve System ( email )

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