The Excess Sensitivity of Long-term Interest rates and Central Bank Credibility

53 Pages Posted: 18 Dec 2020 Last revised: 3 Mar 2023

See all articles by Kwangyong Park

Kwangyong Park

Economist, Economic Research Institute, The Bank of Korea

Date Written: December 16, 2020

Abstract

English Abstract: Long-term interest rates show considerable reactions to macroeconomic and monetary policy news. It is, however, difficult to be explained by standard rational expectations macro-finance models widely used in policy analyses. In this research, we demonstrate that private’s subjective beliefs and central bank credibility can account for the excess sensitivity of long-term interest rates using an estimated macro-finance model which incorporates private’s subjective perceptions on future real activity and inflation and endogenously evolving central bank credibility. We find that long-term rates respond stronger to macro shocks and shifts in private's perceptions regarding expected real activity and inflation when credibility is lower. In addition, the model simulation shows that 10-year yield varies substantially more when credibility is low.

Keywords: Monetary Policy, Credibility, Term Structure, Excess Volatility

JEL Classification: E03, E43, E58, D80

Suggested Citation

Park, Kwangyong, The Excess Sensitivity of Long-term Interest rates and Central Bank Credibility (December 16, 2020). Economic Modelling, Vol. 106, No. 105708, 2022, Bank of Korea WP 2020-29, Available at SSRN: https://ssrn.com/abstract=3749778 or http://dx.doi.org/10.2139/ssrn.3749778

Kwangyong Park (Contact Author)

Economist, Economic Research Institute, The Bank of Korea ( email )

110, 3-Ga, Namdaemunno, Jung-Gu
Seoul 100-794
Korea, Republic of (South Korea)

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