A Macroeconomic Approach to the Term Premium

June 15, 2018

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Format: Chicago

Emanuel Kopp, and Peter D. Williams A Macroeconomic Approach to the Term Premium, (USA: International Monetary Fund, 2018) accessed November 8, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

In recent years, term premia have been very low and sometimes even negative. Now, with the United States economy growing above potential, inflationary pressures are on the rise. Term premia are very sensitive to the expected future path of growth, inflation, and monetary policy, and an inflation surprise could require monetary policy to tighten faster than anticipated, inducing to a sudden decompression of term and other risk premia, thus tightening financial conditions. This paper proposes a semi-structural dynamic term structure model augmented with macroeconomic factors to include cyclical dynamics with a focus on medium- to long-run forecasts. Our results clearly show that a macroeconomic approach is warranted: While term premium estimates are in line with those from other studies, we provide (i) plausible, stable estimates of expected long-term interest rates and (ii) forecasts of short- and long-term interest rates as well as cyclical macroeconomic variables that are stunningly close to those generated from large-scale macroeconomic models.

Subject: Bonds, Financial institutions, Financial services, Inflation, Labor, Prices, Short term interest rates, Unemployment, Yield curve

Keywords: Bonds, Core PCE inflation series, Hike cycle, Inflation, Inflation expectation, Inflation variable, Interest rate expectation, Interest rate forecast, New York Fed conduct, Risk-free rate, Short term interest rates, State Space, Term premium, Term structure of interest rates, Unemployment, WP, Yield curve

Publication Details

Pages:

22
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2018/140
Stock No:

WPIEA2018140
ISBN:

9781484362150
ISSN:

1018-5941

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