Monetary Policy, Bond Risk Premia, and the Economy

This paper develops an affine model of the term structure of interest rates in which bond yields are driven by observable and unobservable macroeconomic factors. It imposes restrictions to identify the effects of monetary policy and other structural disturbances on output, inflation, and interest rates and to decompose movements in long-term rates into terms attributable to changing expected future short rates versus risk premia. The estimated 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. JEL: E32, E43, E44, E52, G12. ∗Please address correspondence to: Peter N. Ireland, Boston College, Department of Economics, 140 Commonwealth Avenue, Chestnut Hill, MA 02467-3859. [email protected]. https://www2.bc.edu/peterireland. I received no external support for and have no financial interest that relates to the research described in this paper. In addition, the opinions, findings, conclusions, and recommendations expressed herein are my own and do not necessarily reflect those of the Trustees of Boston College or of the National Bureau of Economic Research.