Monetary policy and the term structure of nominal interest rates: Evidence and theory

Abstract

This paper explores how exogenous impulses to monetary policy affect the yield curve for nominally risk-free bonds. Three distinct identification strategies imply similar patterns: a contractionary policy shock induces a pronounced positive but short-lived response of short-term interest rates. The response declines monotonically with maturity; long-term rates are virtually unaffected. These responses are unambiguously liquidity effects rather than expected inflation effects. Monetary-policy shocks account for a relatively small fraction of the long-run variance of interest rates. We find that a limited participation model of monetary nonneutrality is broadly consistent with these empirical patterns.