Monetary Policy and the Yield Curve at Zero Interest: The Macro-Finance Model of Interest Rates as Options

September 2006
Hibiki Ichiue^*1
Yoichi Ueno^*2

Click on wp06e16.pdf to download the full text.

Abstract

A macro-finance model combined with Black's (1995) model of interest rates as options is employed to investigate the relationship between the yield curve and monetary policy under Japan's zero interest rate environment. The results indicate a strong effect on nominal yields, but not on real yields, under current Bank of Japan policy. This is because the zero rate creates a close link between real yields and expected inflation rates, which are harder to control than expected nominal short rates are. The results also indicate a very flat real yield curve, one that is more stable than the nominal one.

JEL classification: E43; E52

Keywords:
Macro-finance, Black's model of interest rates as options, Real interest rates, Monetary policy, Zero interest rate policy

We would like to thank Andrew Ang, Naohiko Baba, David Backus, Richard Clarida, Monica Piazzesi, Etsuro Shioji, Mark Spiegel, Eric Swanson, David Vestin and seminar participants at the Bank of Japan for their helpful comments. The views expressed here are ours alone, and do not necessarily reflect those of the Bank of Japan.

*1 Economist and Deputy Director, Financial Markets Department, Bank of Japan
e-mail: hibiki.ichiue@boj.or.jp
*2 Economist, Financial Markets Department, Bank of Japan
e-mail: youichi.ueno@boj.or.jp

Notice

Papers in the Bank of Japan Working Paper Series are circulated in order to stimulate discussions and comments. The views expressed are those of the authors and do not necessarily reflect those of the Bank.

If you have any comments or questions on the working paper series, please contact either author.