Targeting Long Rates in a Model with Segmented Markets

Charles T. Carlstrom · Timothy Stephen Fuerst · Matthias O. Paustian

102 citations0/0 files storedAmerican Economic Journal Macroeconomics

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Monetary Policy and Economic Impact Banking stability, regulation, efficiency Economic theories and models

Abstract

This paper develops a model of segmented financial markets in which the net worth of financial institutions limits the degree of arbitrage across the term structure. The model is embedded into the canonical Dynamic New Keynesian (DNK) framework. We estimate the model using data on the term premium. Our principal results include the following. First, the estimated segmentation coefficient implies a nontrivial effect of central bank asset purchases on yields and real activity. Second, there are welfare gains to having the central bank respond to the term premium, e.g., including the term premium in the Taylor Rule. Third, a policy that directly targets the term premium sterilizes the real economy from shocks originating in the financial sector. A term-premium peg can have significant welfare effects. (JEL E12, E23, E31, E43, E44, E52, E58)

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References

2010A model of unconventional monetary policy 2000Optimal monetary policy with staggered wage and price contracts 1970Optimal Choice of Monetary Policy Instruments in a Simple Stochastic Macro Model 2012International Journal of Central Banking 2001Fiscal Requirements for Price Stability 2009Credit Spreads and Monetary Policy 2013Pricing the term structure with linear regressions 2012The Macroeconomic Effects of Large‐scale Asset Purchase Programmes

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