Oreste Tristani (European Central Bank): Monetary policy and long-term interest rates
Co-author: Gianni Amisano
A few recent articles have argued that calibrated DSGE models, provided they are solved nonlinearly, can match well key empirical features of long-term interest rates. This paper studies the implications of these
ndings for the transmission of monetary
policy, based on a model estimated on US macro and yields data over the 1966-2008 period. Regime shifts in the conditional variance of productivity shocks are an important model ingredient. Switches between "normal" and "high" levels of volatility are found
to be countercyclical and to play an important role in driving cyclical uctuations. At the onset of recessions, volatility tends to increase to high levels: this "uncertainty shock" leads both to a persistent increase in precautionary saving, which drives down consumption, ination and thus current and expected interest rates, and to an increase in risk premia. During the recovery, these dynamics are reversed: volatility returns to normal, low levels, consumption and ination increase, interest rates are expected to go up persistently, while risk premia become lower. Model-implied 10-year ination expectations are broadly in line with those based on survey data over the 1980s and 1990s, but less rmly anchored in the 2000s.
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