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BOK Working Paper No.2020-29, The Excess Sensitivity of Long-term Interest rates and Central Bank Credibility

Economic Research Institute (82-2-759-5452) 2020.12.16 5636

Title : The Excess Sensitivity of Long-term Interest rates and Central Bank Credibility

Author : Kwangyong Park(BOK) 

<Abstract>

Long-term interest rates show considerable reactions to macroeconomic and monetary policy news. It is, however, difficult to be explained by standard rational expectations macro-finance models widely used in policy analyses. In this research, we demonstrate that private’s subjective beliefs and central bank credibility can account for the excess sensitivity of long-term interest rates using an estimated macro-finance model which incorporates private’s subjective perceptions on future real activity and inflation and endogenously evolving central bank credibility. We find that long-term rates respond stronger to macro shocks and shifts in private's perceptions regarding expected real activity and inflation when credibility is lower. In addition, the model simulation shows that 10-year yield varies substantially more when credibility is low.

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