A Macro-Finance Model of the Term Structure, Monetary Policy and the Economy*


  • *

     For helpful comments, we thank participants at the 2004 FRBSF-Stanford conference on ‘Interest Rates and Monetary Policy’, the FRB Cleveland term structure workshop, and the NBER Summer Institute, as well as many colleagues in the Federal Reserve System and Greg Duffee, Bennett McCallum, Oreste Tristani, Peter Tinsley and Hans Dewachter. Vuong Nguyen provided excellent research assistance. The views expressed in this article do not necessarily reflect those of others in the Federal Reserve System.


This article develops and estimates a macro-finance model that combines a canonical affine no-arbitrage finance specification of the term structure of interest rates with standard macroeconomic aggregate relationships for output and inflation. Based on this combination of yield curve and macroeconomic structure and data, we obtain several interesting results: (1) the latent term structure factors from no-arbitrage finance models appear to have important macroeconomic and monetary policy underpinnings, (2) there is no evidence of a slow partial adjustment of the policy interest rate by the central bank, and (3) both forward-looking and backward-looking elements play roles in macroeconomic dynamics.