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Optimal Monetary Policy, the Zero Bound and the Term Structure of Interest Rates

47 Pages Posted: 3 Aug 2004  

Sven R. Skallsjö

affiliation not provided to SSRN

Date Written: March 15, 2004

Abstract

The paper studies optimal monetary policy and its implication for the term structure of interest rates when the nominal short rate is bounded at zero. We state the monetary authority's optimization problem in continuous time according to two specifications, interest rate stabilization and interest rate smoothing. For the former the optimization problem is solved analytically, while numerical procedures are adopted for the latter. The paper then turns to study implications for the term structure of interest rates under risk-neutrality. Term structure equations are solved numerically and implications for yield curves and yield volatility curves are discussed. Data for a low-interest rate country like Japan for 1996-2003 exhibits s-shaped yield curves and yield volatility curves. According to our results this shape is consistent with a smoothing objective for the short rate.

Suggested Citation

Skallsjö, Sven R., Optimal Monetary Policy, the Zero Bound and the Term Structure of Interest Rates (March 15, 2004). EFA 2004 Maastricht Meetings Paper No. 4096. Available at SSRN: https://ssrn.com/abstract=564885 or http://dx.doi.org/10.2139/ssrn.564885

Sven Skallsjö (Contact Author)

affiliation not provided to SSRN

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