Portal Red Investigadores de Economía

The term structure of interest rates is a rich source of economic information and thus can be a powerful tool for policy making. However, this information is difficult to extract given its dependence on the actual policy regime and the existence of time-varying term premia. This paper provides an analysis of the economic content of interest rates when term premia vary over time and monetary policy is optimal. The analysis is complemented with a potentially welfare-improving application for policy making: the formulation of optimal policy rules based on term-structure information. The analysis is conducted for policies with high or low weights on inflation stabilization. It shows that a high inflation weight increases the compensation for real risks in the term structure. As a result, forward rates are less informative about expected future monetary policy, and the term spreads and short-term rate predict better real economic activity and inflation, respectively. In addition, the optimal responses in an interest-rate rule to the lagged short-rate and term spreads decline.

The Economic Content of Interest Rates, Monetary Policy and Time-Varying Risk Premia