-
Developments in Macro-Finance YieldCurve Modelling
Changes in the shape of the yield curve have traditionally been
one ofthe key macroeconomic indicators of a likely change in
economic outlook.However, the recent financial crises have created
a challenge to the manage-ment of monetary policy, demanding a
revision in the way that policymakersmodel expected changes in the
economy. This volume brings togethercentral bank economists and
leading academic monetary economists topropose new methods for
modelling the behaviour of interest rates. Topicscovered include:
the analysis and extraction of expectations of future mon-etary
policy and inflation; the analysis of the short-term dynamics of
moneymarket interest rates; the reliability of existing models in
periods of extrememarket volatility and how to adjust them
accordingly; the role of govern-ment debt and deficits in affecting
sovereign bond yields and spreads. Thisbook will interest financial
researchers and practitioners as well as academicand central bank
economists.
J A G J I T S . C H A D H A is Professor of Economics at the
University of Kentand is on the Advisory Board of the Centre of
International Macroeco-nomics and Finance at the University of
Cambridge. His research involvesincorporating financial factors in
macroeconomic models and he has actedas an adviser to many central
banks throughout the world.
A L A I N C . J . D U R R É is Principal Economist in the
Financial ResearchDivision of the Directorate General Research of
the European Central Bankand is Associate Professor of Finance at
IÉSEG-School of Management atLille Catholic University. He has
published various papers on monetary andfinancial economics in many
leading academic journals and he has acted asMonetary Policy
Adviser for the International Monetary Fund.
M I C H A E L A. S . J OY C E is an Adviser in the Macro
Financial AnalysisDivision of the Bank of England and has over
twenty years’ experienceworking at the Bank of England in various
economics roles. His recentresearch has focused on modelling the
term structure of interest rates andon analysing the effects of the
UK’s quantitative easing policy.
L U C I O S A R N O is a Professor of Finance, Deputy Dean and
Head of theFinance Faculty at Cass Business School, City University
London. Hismain research interests are in international finance,
and he is a leadingexpert on exchange rates, a subject on which he
writes prolifically andon which he is routinely called for advice
by governments, internationalorganisations, and financial companies
around the world.
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Macroeconomic Policy Making
Series editors
Professor JAGJIT S. CHADHA University of Kent,
CanterburyProfessor SEAN HOLLY University of Cambridge
The 2007–2010 financial crisis has asked some very hard
questions of modernmacroeconomics. The consensus that grew up
during ‘the Great Moderation’has proved to be an incomplete
explanation for how to conduct monetary policyin the face of
financial shocks. This series brings together leading
macroeco-nomic researchers and central bank economists to analyse
the tools and methodsnecessary to meet the challenges of the post-
financial crisis world.
Published titles:Chadha and Holly Interest Rates, Prices and
Liquidity: Lessons from the FinancialCrisisCoffman, Leonard and
Neal Questioning Credible Commitment: Perspectives on theRise of
Financial Capitalism
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Developments inMacro-Finance Yield CurveModelling
Edited by
Jagjit S. ChadhaAlain C. J. DurréMichael A. S. JoyceLucio
Sarno
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University Printing House, Cambridge CB2 8BS, United Kingdom
Published in the United States of America by Cambridge
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First published 2014
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Contents
List of figures page viiiList of tables xiiiList of contributors
xviForeword xixPreface xxiii
1 Editors’ introductory chapter and overview 1J. S . C H A D H A
, A . C . J . D U R R É ,M . A . S . J OY C E A N D L . S A R N
O
Part I Keynote addresses
2 Is the long-term interest rate a policy victim, a
policyvariable or a policy lodestar? 19P H I L I P T U R N E R
3 Sovereign debt and monetary policy in the euro area 56A L A I
N C . J. D U R R É A N D F R A N K S M E T S
4 The Federal Reserve’s response to the financial crisis:what it
did and what it should have done 90D A N I E L L . T H O R N T O
N
5 Tail risks and contract design from a financial
stabilityperspective 121PAT R I K E D S PA R R A N D PA U L F I S H
E R
Part II New techniques
6 Compound autoregressive processes and defaultablebond pricing
141A L A I N M O N F O R T A N D J E A N -PA U L R E N N E
v
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vi Contents
7 Yield curve dimensionality when short rates are nearthe zero
lower bound 169J A M E S M . S T E E L E Y
8 The intelligible factor model:international comparison and
stylized facts 200Y VA N L E N G W I L E R A N D C A R L O S L E N
Z
9 Estimating the policy rule from money market rateswhen target
rate changes are lumpy 216J E A N -S É B A S T I E N F O N TA I N
E
10 Developing a practical yield curve model: an odyssey 251M . A
. H . D E M P S T E R , J A C K E VA N SA N D E L E N A M E D O
VA
Part III Policy
11 The repo and federal funds markets before, during,and
emerging from the financial crisis 293M O R T E N B E C H, E L I Z
A B E T H K L E E A N DV I K T O R S S T E B U N O V S
12 Taylor rule uncertainty: believe it or not 326A N D R E A B U
R A S C H I , A N D R E A C A R N E L L IA N D PA U L W H E L A
N
Part IV Estimating inflation risk
13 Inflation compensation and inflation risk premia inthe euro
area term structure of interest rates 361J U A N A N G E L G A R C
Í A A N D T H O M A S
W E R N E R
14 The predictive content of the yield curvefor inflation 390H A
N S D E WA C H T E R , L E O N A R D O I A N I AA N D M A R C O LY
R I O
15 Inflation risk premium and the term structure ofmacroeconomic
announcements in the euro area andthe United States 412M A R C E L
L O P E R I C O L I
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Contents vii
Part V Default risk
16 A term structure model for defaultable Europeansovereign
bonds 457P R I S C I L L A B U R I T Y, M A R C E L O M E D E I R O
SA N D L U C I A N O V E R E D A
17 Some considerations on debtand interest rates 504L U I G I M
A R AT T I N , PA O L O PA E S A N IA N D S I M O N E S A L O T T
I
Index 534
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Figures
2.1 Real long-term Treasury yields page 202.2 Outstanding debt
of domestic US non-financial
borrowers 232.3 Lightening the interest expense of heavy debt
242.4 Net interest payments and household debt service ratio 252.5
Incentives for interest rate carry trades 262.6 Propensity to save
in developing Asia 282.7 Issuance of AAA-rated securities 302.8
Issuance of AAA-rated securities: fixed-rate 312.9 Maturity of US
government bonds 463.1 Money market spreads at various maturities
in the
euro area 663.2 Evolution of public finances in
industrialised
countries from 2005 (% of GDP) 663.3 General government deficit
within the euro area
(% of GDP) 673.4 General government gross debt within the euro
area
(% of GDP) 683.5 10-year government bond spreads against
German
Bunds 693.6 Composite Index of Systemic Stress (CISS) indicator
703.7 Contagion from government to banking sector 713.8 Covered
bond spreads against 5-year swap rate
(daily, basis points) 733.9 Outstanding open market operations
of the Eurosystem 753.10 The euro area deposit (unsecured) market:
yield
curve of spreads against OIS 763.11 The euro area repo (secured)
market: yield curve of
spreads against OIS 763.12 Tensions on sovereign debt and money
market: link
between Greece’s CDS premium (5-year) and the3-month EURIBOR-OIS
spreads 77
viii
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List of figures ix
3.13 CDS premium of Portugal and Ireland and3-month EURIBOR-OIS
spreads 78
3.14 Composite bank lending rate for non-financialcorporations
(% per annum) 79
3.15 Composite bank lending rate for private households(% per
annum) 80
4.1 The 1-month Libor-OIS and CD-Treasury spreads 974.2 The
6-month Libor-OIS and AAA
industrial-Treasury spreads 974.3 The monetary base, the federal
funds rate, and the
funds rate target 984.4 The federal funds rate, funds rate
target, and
1-month OIS rate 994.5 The spread between 10-year AAA industrial
and
Treasuries 1024.6 The 10-year Treasury yield 1044.7 The federal
funds rate target 1086.1 Examples of Car processes 1546.2 Modelling
the term-structure of sovereign spreads
(Spain vs Germany): model fit and credit risk premia 1626.3
Historical vs risk-neutral probabilities of default 1647.1 Average
spot and forward yield curves 1707.2 Level, slope and curvature
components of Nelson
and Siegel spot and forward curves 1747.3 The forward curve and
gilt purchases of similar
maturities 1877.4 The forward curve and gilt purchases across a
range
of maturities 1887.5 Influence of the first principal component
on the
yield curve 1937.6 Influence of the second principal component
on the
yield curve 1947.7 Influence of the third principal component on
the
yield curve 1957.8 Influence of the fourth principal component
on the
yield curve 1968.1 Long, short, and curvature loadings for the
three
countries 2028.2 Impulse-response functions 2068.3 Term
structure of interest rate variance and the
shares that it attributes to innovations into the threefactors
207
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x List of figures
8.4 Long, short, and curvature factors for the threecountries
209
8.5 Impulse-response functions with 95% confidencebands for the
three data sets 214
9.1 The target federal funds rate and the 6-monthahead federal
funds futures rates 220
9.2 The spread between the effective overnight Fedfunds rate and
the Fed’s target rate 230
9.3 Estimate of the parameter controlling the price ofmacro
risk, λz,t, from the Gaussian model and thediscrete model 239
9.4 Correlations of the macro factor and the ADS index 2409.5
The filtered values of the macro factor and the ADS
index 2419.6 The filtered values of the macro factor in
2007–2011 2419.7 Evolution of the macro factor between November
2008 and December 2011 24210.1 BDFS model in-sample implied
yield curves 26410.2 Vasicek model in-sample implied yield curves
26710.3 JSZ/HW model in-sample local optimum implied
yield curves 27610.4 JSZ/HW model long-term implied yield curves
in-
and out-of-sample 27810.5 JSZ/HW 10-year rate distribution
out-of-sample
evolution quantiles from 30 December 2011 28110.6 Black model
non-negative 10-year rate distribution
out-of-sample evolution quantiles from 30December 2011 285
10.7 Black model long-term non-negative yield curves 28611.1
Spread between federal funds and Treasury GC repo 29511.2 Primary
dealers repurchase agreement volume 29811.3 Federal funds market
volume 30011.4 Net Treasury securities issuance and Treasury
General Account balance 30712.1 Interest rate smoothing 34012.2
Inflation response 34112.3 Output response 34212.4 Cross-sectional
R̄2 34312.5 Disagreement about the Taylor rule 34412.6
Non-parametric analysis 34512.7 Disagreement about the parameters
of the Taylor rule 34712.8 Ambiguity about the parameters of the
Taylor rule 348
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List of figures xi
12.9 Disagreement vs ambiguity: inflation loading 34912.10
Disagreement vs ambiguity: output gap loading 35012.11 Monetary
policy uncertainty 35112.12 Term structure of uncertainty 35213.1
BEIR ending in one year 37013.2 One-year forward BEIR ending in two
years 37113.3 One-year forward BEIR ending in five years 37113.4
Term structure model measurement equations:
fitted and observed values 37213.5 Measurement errors for
nominal and real yields:
observed over fitted values 37513.6 Estimated and model-free
measures of long-term
inflation risk premium 38214.1 10-year yield spread: fitted
value and expectations
and term premium components 40014.2 Historical decomposition:
conundrum period 40214.3 Historical decomposition: current
financial crisis 40315.1 United States: breakeven inflation rates,
expected
inflation rates and risk premia 43415.2 Euro area: breakeven
inflation rates, expected
inflation rates and risk premia 43515.3 Constrained and
unconstrained factor loadings 43815.4 Impulse response function of
forward inflation rates 44015.5 Cross-correlogram between
macroeconomic and
monetary news 44015.6 Impulse response functions 44416.1 1-year
sovereign bond yield spread (% pa) –
selected countries 46516.2 Central government budget deficit
46616.3 Deficit vs 1-year bond yield spreads – 4 quarters
moving average 46716.4 Moody’s high yield and 10-year bond
yields,
scatter-plots 46916.5 1-year bond yield spread estimated
composition 47116.6 1-year bond yield spread estimated
composition – only Germany-related factors 47216.7 EN factor
loadings of HY, GeDeb, IP, Infl, Def and
Deb for the three countries as a function of maturity N 47316.8
Impulse response functions for Italy 47416.9 Impulse response
functions for Spain 47516.10 Impulse response functions for Greece
476
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xii List of figures
16.11 Path of Θt for maturities of 1, 5 and 10 years forItaly,
Spain and Greece 478
16.12 1-year sovereign bond yield spread (% pa) – Italy,Spain
and Greece 479
16.13 1-year sovereign bond yield spread (% pa) – Italyand
Spain. Sample: January 1999 to December 2011 480
16.14 EN factor loadings of HY, GeDeb, IP, Infl, Def andDeb for
Italy and Spain as a function of maturity N.Sample: January 1999 to
December 2011 481
16.15 Impulse response functions for Italy – Sample:January 1999
to December 2011 482
16.16 Impulse response functions for Spain – Sample:January 1999
to December 2011 483
16.17 Deficit (ex-interest rate payments) as a percentageof GDP
484
17.1 Debt and interest rates in the USA, Germany and Italy
51817.2 Impact of a 1% debt/GDP shock on four different
variables, the USA 52117.3 Impact of a 1% debt/GDP shock on four
different
variables, Germany 52217.4 Impact of a 1% debt/GDP shock on four
different
variables, Italy 52217.5 Impact of fiscal shocks, comparative
analysis:
1983:1–2009:4 vs 1983:1–2011:4 524
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Tables
2.1 Standard deviations of interest rate changes page 222.2
Floating rate issuance of AAA-rated securities by sector 312.3
Composition of marketable US Federal government
debt held by the public 492.4 Activity in US Treasuries 494.1
Average annual rates of inflation, output growth,
and unemployment 1084.2 Estimates of the equation
pst = α + βgapurt−1 + δgapinft−1 + εt 1107.1 Fit and smoothness
of yield curves of increasing
dimensionality 1797.2 Stability of yield curve dimensionality
prior to QE 1817.3 Key QE announcements relating to UK
government
bonds 1837.4 Effects of QE on the smoothness of yield curves
of
increasing dimensionality 1847.5 Gilt purchases and the fit of
the yield curve 1857.6 Variation is the yield curve explained by
the first
four principal components 1918.1 Correlation coefficients of
factor innovations (u)
and first differences of yields of particular maturities 2109.1
Summary statistics 2269.2 Effective spread parameters 2299.3 Policy
rule parameters 2319.4 Pricing errors 2339.5 Gaussian term
structure model 2349.6 Discrete term structure model 2359.7
Discrete support model – priced target risk 2379.8 Policy
announcements 2008–2011 2439.9 Frequency ratio of changes in
interest rates 247
xiii
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xiv List of tables
10.1 Properties of evaluated yield curve models withregard to
stylised facts 287
11.1 Normal times: January 2002–August 2007 31111.2 Crisis:
August 2007–December 2008 31611.3 Extended period: December
2008–June 2010 32012.1 Consensus Taylor rule regressions 33712.2
Monetary policy uncertainty projections 35312.3 Treasury volatility
risk premia 35513.1 Summary statistics of euro area yield curve
data 36713.2 Volatility of survey and model inflation expectations
36913.3 The fitting of nominal bond yields under different
model specifications 37013.4 Parameter estimation (benchmark
model specification) 37313.5 Model decomposition of spot breakeven
inflation rates 37613.6 Bond liquidity measures and model-based
distortions in observed bond yields 37813.7 Decomposition of
inflation compensation (BEIRs) 38014.1 Variance decomposition of
yield spreads 40114.2 Forecasting core PCE inflation 40615.1
Economic variable surprises 42015.2a USA: impact of surprises
42515.2b Euro area: impact of surprises 42615.3a United States:
yield pricing errors in basis points 43115.3b Euro area: yield
pricing errors in basis points 43115.4 Parameter estimates 43215.5
Correlation of latent factors with observable variables 43315.6
Monetary surprises on nominal and real rates before
and after the Lehman collapse 43915.7 Macroeconomic surprises on
nominal and real rates
before and after the Lehman collapse 44216.1 Autocorrelation of
yields, spreads and the three first
principal components of yields or spreadsorthogonalised with
respect to the macroeconomicand risk factors 463
16.2 Debt to GDP ratio from 2000Q1 to 2010Q3 –Granger causality
tests 464
16.3 Parameter estimates – Germany 49316.4 Parameter estimates –
Italy 49616.5 Parameter estimates – Spain 49816.6 Parameter
estimates – Greece 50017.1 USA: quarterly data 52817.2 Unit root
tests (1983:1–2009:4) 528
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List of tables xv
17.3 Johansen trace cointegration test 52817.4 Germany:
quarterly data 52917.5 Unit root tests (1983:1–2009:4) 52917.6
Johansen trace cointegration test 52917.7 Italy: quarterly data
53017.8 Unit root tests (1983:1–2009:4) 53017.9 Johansen trace
cointegration test, USA 530
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Contributors
M O R T E N B E C H Bank for International Settlements
A N D R E A B U R A S C H I University of Chicago
P R I S C I L L A B U R I T Y Pontifical Catholic University of
Rio de Janeiro
A N D R E A C A R N E L L I Imperial College London
J A G J I T S . C H A D H A University of Kent and CIMF,
University ofCambridge
M I C H A E L D E M P S T E R University of Cambridge
H A N S D E WA C H T E R National Bank of Belgium and University
ofLeuven
A L A I N C . J. D U R R É European Central Bank and
IÉSEG-School ofmanagement
PAT R I K E D S PA R R Visiting Fellow, Bank of England
J A C K E VA N S evalueFE
PA U L F I S H E R Bank of England
J E A N -S É B A S T I E N F O N TA I N E Bank of Canada
J U A N A N G E L G A R C Í A European Central Bank
L E O N A R D O I A N I A Louvain School of Management, National
Bankof Belgium and KU Leuven
M I C H A E L A . S . J OY C E Bank of England
E L I Z A B E T H K L E E Federal Reserve Board
Y VA N L E N G W I L E R University of Basel
C A R L O S L E N Z Swiss National Bank
xvi
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List of contributors xvii
M A R C O LY R I O Insper Institute for Education and
Research
L U I G I M A R AT T I N University of Bologna
M A R C E L O M E D E I R O S Pontifical Catholic University of
Rio deJaneiro
E L E N A M E D O VA Cambridge Systems
A L A I N M O N F O R T CREST
J E A N -PA U L R E N N E Banque de France
PA O L O PA E S A N I University of Rome, Tor Vergata
M A R C E L L O P E R I C O L I Bank of Italy
S I M O N E S A L O T T I Oxford Brookes University
L U C I O S A R N O City University London
F R A N K S M E T S European Central Bank and KU Leuven
V I K T O R S S T E B U N O V S Federal Reserve Board
J A M E S S T E E L E Y Aston Business School
D A N I E L T H O R N T O N The Federal Reserve Bank of St
Louis
P H I L I P T U R N E R Bank for International Settlements
L U C I A N O V E R E D A Universidade Federal Fluminense
T H O M A S W E R N E R European Central Bank
PA U L W H E L A N Imperial College London
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Foreword
Macroeconomics and finance are often housed within separate
facul-ties in universities, and within separate divisions in
central banks. Inthe real world, however, the two are intimately
related. Savers, bor-rowers and investors meet through financial
markets and institutions.Insurance markets support the pooling,
distribution and diversificationof risks. Money markets underpin
the most basic plumbing of mod-ern economies: the payment systems
through which we pay for goodsand services, in different
currencies, anywhere in the world. Banks com-bine the provision of
credit, payments and liquidity-insurance services.Finance matters
to macro, and vice versa!
Finance theory has made real progress over the past couple of
decadesin modelling yield curves. Armed with, admittedly strong,
‘no arbitrage’assumptions that risk is priced consistently across
the bond market at alltimes, this allowed a measure of the markets’
beliefs about the path ofshort-term interest rates to be derived
from the term structure of for-ward interest rates. Together with
similar information from index-linkedgovernment debt, this unlocked
the extraction of estimates of inflationexpectations at different
horizons - vitally important for monetary policymakers, and also
for legislators and the public in holding independentcentral banks
accountable for the price-stability goal they have set us.
Although no-arbitrage provides a means of deriving risk premia,
mea-suring and explaining the various risk premia priced into
different finan-cial contracts remains one of the biggest
challenges for macro-finance.This is not only a technical question
for finance. Macroeconomic policy-makers need to understand the
real economy counterparts to identifiedshifts in risk premia. For
example, does a fall in long-term rates driven bya compression in
term premia have the same implications for investmentprospects as a
fall driven by lower expected future central bank
interestrates?
The importance of questions of that kind has been underlined
bycentral banks’ use of quantitative easing given that our
short-term policy
xix
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Cambridge University Press978-1-107-04455-5 - Developments in
Macro-Finance Yield Curve ModellingEdited by Jagjit S. Chadha,
Alain C. J. Durré, Michael A. S. Joyce and Lucio
SarnoFrontmatterMore information
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xx Foreword
interest rates are at, or around, their lower bound. Separately
from anysignals that QE might give about the likely path of the
policy rate, poli-cymakers have purchased longer-term bonds in
order to influence termpremia directly and, through
portfolio-balance effects, the price of otherassets. We have
therefore needed rich models in order to understandthose features
of the real world - preferred habitats, imperfect arbitrage,and the
associated balance sheet constraints amongst intermediaries -that
make this possible, and to identify and forecast the effects of a
givenstock of asset purchases.
The effect of the size and composition of central bank balance
sheetson asset prices touches on old debates about the overlap
between debtmanagement operations and monetary conditions. A 1998
Bank of Eng-land conference1 concluded that, though changes in debt
managementpolicy were unlikely at the margin to have first-order
effects, it was ‘lessclear that large changes in the quantity or
composition of debt [would]not have implications for monetary
conditions’. Fifteen years on, theinfluence of quantitative easing
on long-term interest rates looks to haveover-turned previous
scepticism about the effectiveness of the kind ofoperations
employed in the Federal Reserve’s ‘Operation Twist’ in theearly
1960s.
There is an accumulating body of evidence that central banks’
influ-ence over risk-premia extends beyond unconventional monetary
pol-icy instruments such as quantitative easing. The prevailing
level andexpected path of the risk-free interest-rate matters too.
Movements inlong-term (forward) interest rates following changes in
central bank pol-icy rates appear consistent with a risk channel of
conventional monetarypolicy, with cuts in short-term interest rates
bringing about a compres-sion in term premia as investors adjust
their portfolios in a search foryield.2 Monetary policymakers need
to be alive and open to the possibil-ity that their actions may
well have a bearing on risk-taking in financialmarkets. That need
not imply that monetary policy must routinely beadjusted actively
to meet a financial stability objective. Where risks tofinancial
stability emerge, financial policy tools - the regulation of
banksand other institutions - can be used to address the problem
more directly.
Incorporating a role for changes in risk premia in macroeconomic
fluc-tuations is, I believe, vital to a deeper understanding of the
drivers andimplications of developments within financial markets.
In addition to
1 See Crystal (1999), ‘Government Debt Structure and Monetary
Conditions’ for arecord of the conference proceedings.
2 See Hanson and Stein (2012), ‘Monetary Policy and Long-Term
Real Rates’, HarvardBusiness School Working Paper, No. 13–008, and
Tucker (2012), ‘National Balancesheets and macro policies: lessons
from the past’.
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Cambridge University Press978-1-107-04455-5 - Developments in
Macro-Finance Yield Curve ModellingEdited by Jagjit S. Chadha,
Alain C. J. Durré, Michael A. S. Joyce and Lucio
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Foreword xxi
accounting for term premia, we need macro-models that properly
incor-porate credit risk, including the non-linearities associated
with default.At its core, default is a boundary condition where
debtors are unable,or simply unwilling, to service their
outstanding obligations given thevalue of their assets, including
their prospective future incomes. A real-istic model of credit risk
needs to be able to capture the sharp pick up incredit losses that
can occur when asset values are sufficiently depressed,and trace
through the effects on intermediaries’ net worth. Models
wheredifferent agents’ financing costs vary with net worth, but
without anyprospect of default, are probably not worth much.
Moreover, we prob-ably need models with heterogeneity in levels of
indebtedness acrosshouseholds, firms and, possibly, also
intermediaries.
Real progress also requires macro-finance to re-engage with
banking.“Money and banking” used to be at the core of university
courses inmacroeconomics but, even before the so-called ‘Great
Stability’, cameto be regarded as old fashioned. Sadly, the same
was true in parts ofcentral banking. The costs of the crisis and
the difficulties in gener-ating recovery have put beyond doubt,
once again, the importance ofbanks and other key financial
intermediaries to market liquidity, assetprices, the allocation of
resources to productive ends, and householdand firms’ behaviour. It
is very important that UK-based researchersshould be active in this
field, and this conference engaged with a num-ber of the issues.
With short-term interest rates close to their effectivelower bound,
understanding central banks’ ability to influence aggregatedemand
by acting through a broader range of instruments is crucial
tounderpinning economic recovery. Further ahead, richer models of
theconnections amongst banking (including shadow banking), risk
premiaand macro-economic fluctuations would help to avoid similar
crises inthe future. This timely conference volume addresses issues
that are cen-tral both to the research agenda for macroeconomics
and finance and tothe decisions that policymakers will face as we
emerge from the crisis.
Paul Tucker, former DeputyGovernor of the Bank of England
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Cambridge University Press978-1-107-04455-5 - Developments in
Macro-Finance Yield Curve ModellingEdited by Jagjit S. Chadha,
Alain C. J. Durré, Michael A. S. Joyce and Lucio
SarnoFrontmatterMore information
http://www.cambridge.org/9781107044555http://www.cambridge.orghttp://www.cambridge.org
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Press
Cambridge University Press978-1-107-04455-5 - Developments in
Macro-Finance Yield Curve ModellingEdited by Jagjit S. Chadha,
Alain C. J. Durré, Michael A. S. Joyce and Lucio
SarnoFrontmatterMore information
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Preface
The monetary transmission mechanism relies heavily on the impact
ofthe current level and expected path of policy rates on longer
term inter-est rates paid on government liabilities and a wide
constellation of retailand wholesale borrowings. It is mostly this
transmission of interest ratesalong the maturity and risk spectrum
that gives monetary policy its trac-tion on the wider economy. And
yet much of this transmission wasassumed away in many macroeconomic
models used prior to the eco-nomic crisis: often, even those who
modelled the links did not necessarilydevelop models in which
longer term interest rates reflected liquidityor default risk. The
problems of this assumption emerged with someforce as the evolving
financial and sovereign debt crisis in the euro areabrought to the
fore the intimate relationship between the macroeconomiceconomy and
the financial system. In turn, policymakers have had, inturn, to
rethink many assumptions that have been made about the
rela-tionship between the state, monetary policy and the financial
sector. Theextensive and persistent use of near zero interest rates
at the short endof the term structure has significantly reawakened
research and policyinterest in the link between the yield curve and
the macro economy.
The development of extraordinary policies such as quantitative
andcredit easing, as well as extended open market operations such
as Oper-ation Twist, have been designed to alleviate premia in
longer terminterest rates. And yet we remain at some distance from
understand-ing the impact of signalling and purchases on many key
interest rates.The conference we held at Clare College Cambridge in
September 2011brought together many economists in academia,
financial markets andcentral banks to look afresh at these
relationships and we are pleased tosponsor the publication of the
contributions, which have benefitted fromthe comments of the
conference discussants and also many anonymousreferees.
JAGJIT S. CHADHA AND SEAN HOLLY
xxiii
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Macro-Finance Yield Curve ModellingEdited by Jagjit S. Chadha,
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