Under bond-rate transmission of monetary policy, the authors show that a generalized Taylor Principle applies, in which the average anticipated path of policy responses to inflation is subject to a lower bound of unity. This result helps explain how bond rates may exhibit stable responses to inflation, even in periods of passive policy. Another possible explanation is time-varying term premiums with risk pricing that depends on inflation. The authors present a no-arbitrage model of the term structure with horizon-dependent policy perceptions and time-varying term premiums to illustrate the mechanics and provide empirical results that support these transmission channels.

Published In:

The North American Journal of Economics and Finance (1062-9408)
March 2008. Vol. 19, Iss. 1, pp. 71-92