Research Discussion Papers, Bank of Finland
No 12/1999:
Anticipated Monetary Policy and the Dynamic Behaviour of the Term Structure of Interest Rates
Jarkko Jääskelä and Jouko Vilmunen ()
Abstract: This paper investigates the measurement of anticipated
interest rate policy and the effects of these expectations on the term
structure of nominal interest rates. It is shown that, under the
expectations hypothesis, the level of long-term interest rates depends on
three factors: the level of the monetary policy interest rate, ie the
steering rate; the spread between the market interest rate and the steering
rate; and market expectations of the next steering rate change. The
theoretical model builds on the assumption that market participants have
only imperfect knowledge of the mechanism whereby changes in the steering
rate are determined. As a consequence, expectations formation, although
realistic, need not be entirely rational. Steering rate changes take the
form of discrete jumps and occur infrequently on a daily scale. Given these
assumptions, discussion of the determination of the term structure is
related to the literature on uncertainty about monetary policy regimes and
small samples, ie "peso" problems. Empirical analysis based on
Nelson–Siegel estimates of the daily yield curves in Finland in the period
1 January 1993 to 31 October 1997 complements the theoretical discussion.
The observed differences between estimated market expectations and actual
tender rate changes are quite large in the sample, particularly for the
longer maturities. The approach applied in this study is promising, not
only in the sense of potentially providing estimates of market expectations
concerning future discrete changes in monetary policy interest rates but
also in the sense of its apparent potential in accounting for the often
reported poor empirical performance of the expectations hypothesis.
Keywords: term structure of interest rates; expectations; target changes; peso problems; (follow links to similar papers)
39 pages, September 10, 1999
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