Monetary policy, bond risk premia, and the economy

Abstract

Within an affine model of the term structure of interest rates, where bond yields get driven by observable and unobservable macroeconomic factors, parameter restrictions help identify the effects of monetary policy and other structural disturbances on output, inflation, and interest rates and decompose movements in long-term rates into terms attributable to changing expected future short rates versus risk premia. When estimated, the model highlights a broad range of channels through which monetary policy affects risk premia and the economy, risk premia affect monetary policy and the economy, and the economy affects monetary policy and risk premia.