Working Paper: NBER ID: w4938
Authors: Bennett T. McCallum
Abstract: This paper addresses a prominent empirical failure of the expectations theory of the term structure of interest rates under the assumption of rational expectations. This failure concerns the magnitude of slope coefficients in regressions of short rate (or long- rate) changes on long-short spreads. It is shown that the anomalous empirical findings can be rationalized with the expectations theory by recognition of an exogenous random (but possibly autoregressive) term premium plus the assumption that monetary policy involves smoothing of an interest rate instrument -- the short rate -- together with the responses to the prevailing level of the spread.
Keywords: Monetary Policy; Term Structure; Interest Rates
JEL Codes: E43; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| monetary policy actions (e.g., smoothing) (E52) | short and long rates correspondence failure (E43) |
| monetary policy decisions (E52) | term structure of interest rates (E43) |
| current short rate and prevailing spread (E43) | expected future short rate (G17) |
| term premium (E43) | slope of regression between short and long rates (E43) |
| deviation of actual policy behavior (D78) | expectations theory (D84) |