We estimate Taylor (1993) rules and identify monetary policy shocks using no-arbitrage pricing techniques. Long-term interest rates are risk-adjusted expected values of future short rates and thus provide strong over-identifying restrictions about the policy rule used by the Federal Reserve. We find that inflation and GDP growth account for over half of the timevariation of yield levels and we attribute almost all of the movements in the term spread to inflation. We find that Taylor rules estimated with no-arbitrage restrictions differ substantially from Taylor rules estimated by OLS and monetary policy shocks identified with no-arbitrage techniques are less volatile than their OLS counterparts. The no-arbitrage framework also accommodates backward-looking and forward-looking Taylor rules.
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