The New Keynesian Model and Bond Yields

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Abstract

This paper presents a New Keynesian model to capture the linkages between macro fundamentals and the nominal yield curve. The model explains bond yields with a low level of news in expected inflation and plausible term premia. This implies that the slope of the yield curve predicts future bond returns, and that risk-adjusted historical bond returns satisfy the expectations hypothesis. A key implication of the model is that U.S. bond yields are consistent with demand shocks that are three times less inflationary than implied by a standard log-linearized New Keynesian model estimated without bond yields.
Original languageEnglish
Place of publicationAarhus
PublisherInstitut for Økonomi, Aarhus Universitet
Number of pages41
Publication statusPublished - 9 Jan 2021
SeriesCREATES Research Paper
Number2021-01

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