The Bundesbank's Inflation Policy and Asymmetric Behavior of the German Term Structure

Abstract

In this paper we analyse the influence of the Bundesbank's inflation targeting policy on the behavior of the spread between long-term and short-term German interest rates. The term spread is considered to be a key indicator of future inflation and economic activity. The application of a momentum threshold autoregressive cointegration model enables us to study the adjustment process of the spread toward equilibrium in greater detail than heretofore possible and permits relaxation of the linear and symmetric adjustment assumption underlying conventional cointegration and error correction investigations on the expectations hypothesis. The empirical findings are consistent with the hypothesized asymmetric adjustment behavior of the spread and can be explained by the Bundesbank's inflation targeting policy during the period from 1975 to 1998.

Keywords: Term Structure, Threshold Cointegration, Asymmetric Adjustment, Inflation Targeting Policy of the Bundesbank

JEL Classification: E43, C22, C50