Research Discussion Paper – RDP 2011-02 Long-term Interest Rates, Risk Premia and Unconventional Monetary Policy Abstract

In a model where the risk premium on long-term debt is, in part, endogenously determined, we study two kinds of unconventional monetary policy: long-term nominal interest rates as operating instruments of monetary policy and announcements about the future path of the short-term rate. We find that both policies are consistent with unique equilibria, that long-term interest rate rules can perform better than conventional Taylor rules, and that, at the zero lower bound, announcements about the future path of the short-term rate can lower long-term interest rates through their impact on both expectations and the risk premium. With simulations, we show that long-term interest rate rules generate sensible dynamics both when in operation and when expected to be applied.

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