Economic Quarterly

Fall 2005

Monetary Policy and the Term Structure of Interest Rates

Bennett T. McCallum

A prominent failure of the expectations theory of the term structure of interest rates concerns the magnitude of slope coefficients in regressions of short rate (or long rate) changes on long-short spreads. The anomalous empirical findings can be rationalized with the expectations theory by recognition of an autoregressive term premium plus the assumption that monetary policy involves smoothing of an interest rate instrument—the short rate—together with policy responses to the prevailing level of the spread.

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