“Term Structure, Forecast Revision and the Signaling Channel of Monetary Policy” by Dr. Donghai Zhang
Dr. Donghai Zhang
Bonn Graduate School of Economics
University of Bonn
Monetary policy shocks affect interest rates at long horizons (10 years or more). Furthermore, the private sector’s real GDP forecasts are revised upward in response to a monetary tightening. These facts challenge the prevailing theories in academic and policy circles, which are based on the paradigm that monetary policy has limited long-run effects and a monetary policy tightening should depress agents’ beliefs about real GDP. In this paper, I propose a micro-founded model to rationalize those facts, based on the information channel of monetary policy. I consider a framework where the central bank has private information about future economic conditions. Agents update their beliefs according to Bayes’ theorem. Policy actions play a signaling role, and may therefore have an impact on both short and long-term interest rates. Finally, I discuss the implications of information frictions for the design of optimal simple rule.