Munich Personal RePEc Archive

Federal Reserve Credibility and the Term Structure of Interest Rates

Lakdawala, Aeimit and Wu, Shu (2017): Federal Reserve Credibility and the Term Structure of Interest Rates.

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Abstract

In this paper we show how the degree of central bank credibility influences the level, slope and curvature of the term structure of interest rates. In an estimated structural model, we find that historical yield curve data are best matched by the Federal Reserve conducting policy in a loose commitment framework, rather than the commonly used discretion and full commitment assumptions. The structural impulse responses indicate that the past history of realized shocks play a crucial role in determining the dynamic effects of monetary policy on the yield curve. Finally, the regime-switching framework allows us to estimate likely re-optimization episodes which are found to impact the middle of the yield curve more than the short and long end.

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