Yield Curve and Monetary Policy Expectations in Small Open Economies

56 Pages Posted: 28 Nov 2014 Last revised: 11 Feb 2016

See all articles by Kwan Bong

Kwan Bong

The Bank of Korea

Taeyoung Doh

Federal Reserve Bank of Kansas City

Woong Yong Park

Seoul National University

Date Written: January 2016

Abstract

This paper estimates a New Keynesian dynamic stochastic general equilibrium (DSGE) model in small open economies using the yield curve data as well as standard macro data. The DSGE model is estimated on the data of three inflation-targeting small open economies (Australia, Canada, and New Zealand) using Bayesian methods. We find that the long-end of the yield curve is highly correlated with the current and future short-term interest rates determined by domestic central banks. Yield curve data are particularly informative about the future stance of monetary policy in Australia and Canada in that the correlation between the model-implied monetary policy expectations and the ex-post realized policy interest rates increases when the yield curve data are used in estimation. In New Zealand, estimation results based on only macro data produce a high correlation between the model-implied interest rate expectations and the ex-post realized interest rates because information from the yield curve has been explicitly incorporated in monetary policy decisions. We also document that a persistent shock to the inflation target driving the average level of the yield curve in these three countries is highly correlated with long-horizon inflation expectations in the U.S., indicating stronger financial linkages.

Keywords: dynamic general equilibrium model, a small open economy model, yield curve, monetary policy expectations

Suggested Citation

Bong, Kwan and Doh, Taeyoung and Park, Woong Yong, Yield Curve and Monetary Policy Expectations in Small Open Economies (January 2016). Federal Reserve Bank of Kansas City Working Paper No. 14-13, Available at SSRN: https://ssrn.com/abstract=2531095 or http://dx.doi.org/10.2139/ssrn.2531095

Kwan Bong

The Bank of Korea ( email )

110, 3-Ga, Namdaemunno, Jung-Gu
Seoul 100-794, 100-794

Taeyoung Doh (Contact Author)

Federal Reserve Bank of Kansas City ( email )

1 Memorial Dr.
Kansas City, MO 64198
United States

Woong Yong Park

Seoul National University ( email )

Kwanak-gu
Seoul, 151-742
Korea, Republic of (South Korea)

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