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Shifting
Endpoints in the Term
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Abstract This paper links the term structure to perceptions of monetary policy. Long-horizon forecasts of short rates needed in empirical term structure models are heavily influenced by the endpoints, or limiting conditional forecasts, of the short rate process. Mean-reversion or unit roots are commonly assumed, but do not provide realistic yield predictions. Failures occur because neither accounts for historical shifts in market perceptions of the policy target for inflation. This paper links endpoint shifts to a learning model where agents must detect shifts in long-term policy goals. With shifting-endpoint short rate processes, models better explain yield fluctuations. Keywords: Expectations Hypothesis, changepoints, breakpoints, learning. Sharon Kozicki is a senior economist at the Federal Reserve Bank of Kansas City. P.A. Tinsley is Deputy Associate Director, Division of Research and Statistics, at the Board of Governors of the Federal Reserve System. The authors are grateful for comments received from Arturo Estrella, Charles Nelson, Vance Roley, and seminar participants at the Monetary Policy Effects session of the 1996 Winter Econometrics Society Meetings, the University of Florida, and the April 1996 Federal Reserve System Committee Meeting on Macroeconomics held at the Federal Reserve Bank of San Francisco. The views expressed herein are solely those of the authors and do not necessarily reflect views of the Federal Reserve Bank of Kansas City or the Board of Governors of the Federal Reserve System.Kozicki e-mail: sharon.kozicki@kc.frb.org
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