After nearly a decade of high inflation, a number of important central banks began in 1979 a concreted effort to reign in inflation. The net effect was transition from a global enviroment where inflation seemed a virtually intractable issue to the current era where the major economies of the world enjoy relative price stability. The monetary policy of a country is the process by which the central monetary authority, controls the supply of money in the economy. Through open market operations, the central bank is able to affect the level of money market interest rates. The term structure of interest rates play an important role in determining the effectiveness of monetary policy. The objective of the present paper is to analyse the impact and
…show more content…
The closed form solution gives rise to a multi-factor affine model of the term structure. Although, the policy parameter can not be directly estimated in the model, the qualitative impact on the reduced form coefficients of a change in value of the policy parameter, can be identified. Thererfore, to the affine model of the term structure, econometric tests for structural changes and parameter instability can be applied. In the framework of Andrews, Tests for Parameter Instability and Structural Change with Unknown Change Point published in 1993, the test is first conducted for the case of an exogenously fixed break-point, which is October 1979, when monetary policy is shifted to a new regime. Indeed there was a structural break in the yield curve, confirmed from the Wald, Lagrange Multiplier and Likelihood Ratio test statistics. Estimates of the key reduced form coefficients in the term structure model are largely consistent with a story of a permanent shift in policy stance toward controlling inflation since 1979. Additionally, the test is carried out for the case of an endogenously determined break-point. The data show that in coincidence with the shift in monetary policy by 1979, the structural break in the yield curve indeed
The closed form solution gives rise to a multi-factor affine model of the term structure. Although, the policy parameter can not be directly estimated in the model, the qualitative impact on the reduced form coefficients of a change in value of the policy parameter, can be identified. Thererfore, to the affine model of the term structure, econometric tests for structural changes and parameter instability can be applied. In the framework of Andrews, Tests for Parameter Instability and Structural Change with Unknown Change Point published in 1993, the test is first conducted for the case of an exogenously fixed break-point, which is October 1979, when monetary policy is shifted to a new regime. Indeed there was a structural break in the yield curve, confirmed from the Wald, Lagrange Multiplier and Likelihood Ratio test statistics. Estimates of the key reduced form coefficients in the term structure model are largely consistent with a story of a permanent shift in policy stance toward controlling inflation since 1979. Additionally, the test is carried out for the case of an endogenously determined break-point. The data show that in coincidence with the shift in monetary policy by 1979, the structural break in the yield curve indeed