The Excess Sensitivity of Long-term Interest rates and Central Bank Credibility
53 Pages Posted: 18 Dec 2020 Last revised: 3 Mar 2023
Date Written: December 16, 2020
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: Suggested Citation