Term premia responses to monetary policy shocks and the Expectations Hypothesis
Andrews, W. Brooks
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Understanding how the nominal term structure of interest rates responds to monetary policy is crucial in trying to incorporate such ideas into fundamental equilibrium models that describe the economy as a whole. Here we analyze the effect of a contractionary monetary policy shock on nominal interest rates in order to understand if they respond in a manner consistent with the predictions of the Expectations Hypothesis of the term structure. Particularly, we utilize a structural VAR model and short-run recursiveness assumptions to analyze the responses of various term premia to these contractionary shocks and find that their systematic responses violate the Expectations Hypothesis, leading us to propose alternative explanations for describing the theoretical basis of the term structure.