Do Term Premiums Matter? Transmission Via Exchange Rate Dynamics
44 Pages Posted: 10 Jun 2019
Date Written: May 20, 2019
The macroeconomic effect of term premiums is a controversial issue both theoretically and quantitatively. In this paper, we explore the possibility that term premiums affect inflation and the real economy via exchange rate dynamics. For this purpose, we construct a small open economy model with limited asset market participation, focusing on the empirical fact that uncovered interest parity (UIP) holds better for longer-term interest rate differentials. A quantitative exercise using Japanese and U.S. data shows that changes in term premiums of both Japanese and U.S. long-term yields have sizable effects on Japanese inflation rates via exchange rate dynamics.
Keywords: Exchange Rate; Term Premium; Uncovered Interest Rate Parity
JEL Classification: E31; E52; E58
Suggested Citation: Suggested Citation