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How Do Monetary Policy Rules Affect Term Premia?*1

October 2005
Hibiki Ichiue*2

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  • *1 This paper is a revised version of Chapter 3 of the author's doctoral dissertation submitted to University of California, San Diego in August, 2005, which was mainly written when he worked for the Research and Statistics Department, Bank of Japan. The author is deeply grateful to James D. Hamilton, for his valuable support and comments. The author also thanks Kosuke Aoki, Marjorie Flavin, Alex Kane, Takeshi Kimura, Bruce Lehmann, Allan Timmermann, Tuck Yun, and the seminar participants at the Bank of Japan for their helpful suggestions. All remaining errors are my own. The views expressed in this paper are the author's; they should not be attributed to the Bank of Japan.
  • *2 Research and Statistics Department (currently, Financial Markets Department)
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This paper derives analytical solutions for interest rate term structures in a new Keynesian framework. Theoretically, we consider the conditions for the positive average slope of nominal term structure, and show that the slope of a real one is positive. We then calibrate the model to find the following results. First, term premia represents compensation for risk of time-variation in IS shock rather than cost-push and monetary policy shocks. Second, a small slope of the Phillips curve is needed for a positive slope of the term structure. Third, the term structure of the inflation premium is downward on average. Finally, a less aggressive response to output gap in the monetary policy rule leads to lower term premia. The implication for the recent low long rate is also discussed.

JEL classification:
E43; E52

Term Structure of Interest Rate, Monetary Policy Rule, New Keynesian Model, Term Premium, Inflation Premium