The Term Structure of Interest Rates and Monetary Policy During a Zero-Interest-Rate Period

IMF Working Papers, October 1, 2003

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Canonical URL: The Term Structure of Interest Rates and Monetary Policy During a Zero-Interest-Rate Period

The paper empirically evaluates the validity of the term structure of interest rates in a low-interest-rate environment.
Applying a time-series method to high-frequency Japanese data, the term-structure model is found to be useful for economic analysis only when interest rates are high.
When interest rates are low, the usefulness of the model declines because the interest spread contains little information that can be used for predicting future economic activity.
The term-structure relationship is weakened by the Bank of Japan's use of interest rate smoothing.

Empirical approach: time-series method applied to high-frequency Japanese data.
Focus: informational content of the interest spread for predicting future economic activity across different interest-rate regimes (high vs. low).

The predictive power of the yield curve (term structure) for macroeconomic activity is regime-dependent: reliable when interest rates are high; limited when interest rates are low or at/near the zero lower bound.
Central bank behavior—specifically, the Bank of Japan's interest rate-smoothing behavior—can weaken the term-structure relationship, reducing the interest spread's usefulness as an indicator.
Implicit consideration: alternative indicators or policy tools may be needed when conventional term-structure signals are uninformative in a zero-interest-rate environment.

Subjects: Econometric analysis, Estimation techniques, Financial services, Long term interest rates, Short term interest rates, Yield curve, Zero lower bound
Keywords: BoJ's interest rate-smoothing behavior, Estimation techniques, expectations channel, Global, interest rate channel, Long term interest rates, monetary policy, quantitative-easing policy, reaction function, Short term interest rates, short-term interest rates, WP, Yield curve, zero interest rates, Zero lower bound

IMF Working Paper by Jun Nagayasu (October 1, 2003), Working Paper No. 2003/208. — Source: IMF web landing page for the publication.