Finance and Economics Discussion Series (FEDS)
Real and Nominal Equilibrium Yield Curves: Wage Rigidities and Permanent Shocks
Alex Hsu, Erica X.N. Li, and Francisco Palomino
The links between real and nominal bond risk premia and macroeconomic dynamics are explored quantitatively in a model with nominal rigidities and monetary policy. The estimated model captures macroeconomic and yield curve properties of the U.S. economy, implying significantly positive real term and inflation risk bond premia. In contrast to previous literature, both premia are positive and generated by wage rigidities as a compensation for permanent productivity shocks. Stronger policy-rule responses to inflation (output) increase (decrease) both premia, while policy surprises generate negligible risk premia. Empirical evidence of the economic mechanism is provided.
Keywords: Bond risk premia, Monetary policy, Nominal rigidities, Yield curve
PDF: Full Paper