Optimal Monetary Policy and Term Structure in a Continuous-Time DSGE Model

Learning About the Term Structure and Optimal Rules for Inflation Targeting

Comment

This paper uses a dynamic stochastic general equilibrium (DSGE) model with sticky information as a laboratory to study monetary policy. It characterizes the model's predictions for macro dynamics and optimal policy at prior parameters, and then uses data on five US macroeconomic series to update the parameters and provide an estimated model that can be used for policy analysis. The model answers a few policy questions. How does sticky information affect optimal monetary policy? What is the optimal interest rate rule? What is the optimal elastic price-level targeting rule? How does parameter uncertainty affect optimal policy? Are the conclusions for the Euro area different? (JEL E13, E31, E43, E52)

This paper shows the limitation of the cost-of-carry model which is used for pricing the theoretical value of the KTB futures, and proposes an alternative pricing model based on the term structure of interest rates. Under the assumption of 1-factor term structure, this paper treats the theoretical price of KTB futures price as a risk-neutral expectation of payoff function at maturity and derives the approximated formula for pricing the KTB futures. As compared with our price of KTB futures using the term structure of interest rates, the conventional KOFEX price based on the cost-of-carry model tends to be overvalued as the time to maturity increases. This result is due to the difference between the futures and forward prices which is caused by treating the futures contract as the forward contract in the conventional KOFEX pricing model. In particular, this discrepancy becomes more significant when the price of underlying asset and the interest rates are negatively correlated and the time to maturity is longer. The bond futures contract is a typical example of financial instrument whose price has a negative correlation with interest rates

We analytically characterize optimal monetary policy for an augmented New Keynesian model with a housing sector. With rational private sector expectations about housing prices and inflation, optimal monetary policy can be characterized by a standard ‘target criterion’ that refers to inflation and the output gap, without making reference to housing prices. When the policymaker is concerned with potential departures of private sector expectations from rational ones and seeks a policy that is robust against such possible departures, then the optimal target criterion must also depend on housing prices. For empirically realistic cases, the central bank should then ‘lean against’ housing prices, i.e., following unexpected housing price increases (decreases), policy should adopt a stance that is projected to undershoot (overshoot) its normal targets for inflation and the output gap. Robustly optimal policy does not require that the central bank distinguishes between ‘fundamental’ and ‘non-fundamental’ movements in housing prices.

Financial Shocks and Optimal Policy

At present, China is in the critical stage of transforming from a quantitative monetary policy to a price-based monetary policy. The implementation of a quantitative-price mixed monetary policy can further improve the effect of monetary policy and interest rate regulation and maintain the stable operation of the macro economy. Based on the current economic situation, this article conducts experiments to prove the relationship between its monetary policy and the term structure of interest rates. To this end, this article first analyzes and compares the final effects of monetary policy on regional economies with the aid of an analysis framework that can simultaneously take into account the individuality of regional economies, the spillover effects between regional economies and the overall nature of monetary policy. Then, this article further combines the current background of interest rate marketization and monetary policy from quantity-oriented price-oriented changes. Focusing on the interest rate channel, it deeply analyzes the regional effects and formation of China's monetary policy under the new situation. First of all, on the basis of combing and summarizing relevant literature, find the expansion space for evaluating the regional effect of China's monetary policy. Experimental research results show that the term structure of interest rates is playing an increasingly important role in monetary policy. Combining the study of the term structure of interest rates with monetary policy and examining the relationship between them can not only promote the role of interest rates in macro-control, but also have important implications for improving the forward-looking and effectiveness of monetary policy.

Term Structure of Interest Rates. Review of a Theory of the Term Structure of Interest Rates (CIR)

As already mentioned in great detail in Chapter 1, the whole mathematical finance literature dealing with the term structure of interest rates has abstracted from studying the influence of fiscal policy on the term structure. Usually, arbitrary stochastic dynamics for a given set of ‘factors’1 driving the term structure were introduced by postulating specific forms of diffusion processes representing the evolution of these factors. As a consequence of these ad-hoc approaches, the influence of fiscal policy was either completely neglected or introduced in an ad-hoc way, at best 2. One can, of course, argue that the influence of fiscal policy is already integrated in the factor dynamics used, namely in the way the dynamics are parametrized. This implies that these parameters are seemingly policy invariant. When one argues that the influence of fiscal policy is already embedded in such arbitrary parameters with almost no economic meaning, then estimating these models is subject to criticism similar to the well-known ‘Lucas Critique’ 3. As the respective introductory remarks in Chapter 1 should have made clear, we think that fiscal policy does matter for term structure considerations. We will now discuss the term structure of interest rate and the influence of fiscal policy in the macroeconomic setting laid down in the previous chapter.

The influence of market segmentation on the term structure of interest rates has received considerable attention in recent years. However, an event gone unnoticed in this attention is relaxation in the authority of the Treasury to issue long-term bonds apart from the 41/4 percent interest rate ceiling imposed by Congress. This paper tests the effect of 1971 and 1976 changes in this authority which, in turn, affected the expected supply of long-term relative to short-term securities. In this regard, several widely used expectation models are employed, and new insights are gained into the importance of market segmentation on the term structure of interest rates. The first section of the paper reviews the market segmentation theory while the second investigates the origin, purpose and impact of the 4/4 percent interest rate ceiling. The next section presents the expectations models to be tested, followed by a discussion of the data used. The results of the empirical tests are analyzed in the next section, and implications drawn with respect to the market segmentation theory. Concluding remarks appear in the last section.

This article studies the information content of the term structure of interest rates of Thai government bonds. Using monthly data from July 2001 to December 2013, this article tests whether the term structure contains information about future interest rates, inflation and gross domestic product (GDP) growth. The results suggest that, despite the low liquidity of the Thai government bond market, the term structure contains considerable information about future interest rates and GDP growth. JEL Classification: E43, E44, G12

This paper proposes a term structure of interest rates model that modifies and extends the Campbell and Cochrane (1999) surplus consumption framework. The distinguishing contributions are tractable, continuous-time analytical solutions for the term structure of interest rate generating a realistic upward sloping yield curve. Despite the focus on the term structure, the model matches plausible equity quantities. For the interest rate, the model is able to account for the moments of bond yields at numerous maturities and produce countercyclical bond risk premia as seen in the data. Moreover, the model captures reasonable time series fluctuation on real interest rates. However, the model has difficulties reproducing empirical deviations from the expectations hypothesis.

Leaning Against Housing Prices As Robustly Optimal Monetary Policy

Optimal interest rate rules, asset prices, and credit frictions

The Cap Market, the Term Structure and the Unspanned Factors: Taking Care of Non-Linearity