‘Monetary policy risk: Rules vs. discretion’
by Irina Zviadadze
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Long-run asset-pricing restrictions in a macro term-structure model identify discretionary monetary policy separately from a target-rate policy rule. We find that policy discretion is an important contributor to aggregate risk. In addition, discretionary easing coincides with good news about the macroeconomy in the form of lower inflation, higher output growth, and lower risk premiums on short-term nominal bonds. However, discretionary easing also coincides with bad news about long-term financial conditions in the form of higher risk premiums on long-term nominal bonds. Target-rate changes correlate with changes in the yield curve’s level, whereas discretionary changes correlate with changes in its slope.