The Expectations Theory Works for Monetary Policy Shocks
22 Pages Posted: 19 Jun 2006
In practice, the expectations theory of the term structure is employed extensively in monetary policy analysis despite its empirical failure. This paper performs a conditional test of the theory that is directly relevant to monetary theory and policy. It finds that the theory holds quite well conditional on identified monetary policy shocks, but fails conditional on aggregate supply shocks that prompt an immediate jump in prices. It also finds that policy responses to movements in the term structure play an important role in uncovering evidence for the theory as predicted by McCallum (1994).
Keywords: term structure, monetary policy, structural vector autoregression, simultaneity, identification
JEL Classification: C11, C32, E43, E44, E52
Suggested Citation: Suggested Citation