Should Monetary Policy Use Long-Term Rates?

Abstract

This paper studies two roles that long-term nominal interest rates can play in the conduct of monetary policy in a New Keynesian model. The first allows long-term rates to enter the reaction function of the monetary authority. The second considers the possibility of using long-term rates as instruments of policy. In both cases a unique rational expectations equilibrium exists. Reacting to movements in long yields does not improve macroeconomic performance as measured by the loss function. Long-term rates, however, turn out to be better instruments of monetary policy than short-term rates when the concern for inflation volatility is high.

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