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Working Paper

Targeting Long Rates in a Model with Segmented Markets

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This paper develops a model of segmented financial markets in which the net worth of financial institutions limits the degree of arbitrage across the term structure. The model is embedded into the canonical Dynamic New Keynesian (DNK) framework. We estimate the model using data on the term premium. Our principal results include the following. First, the estimated segmentation coefficient implies a nontrivial effect of central bank asset purchases on yields and real activity. Second, there are welfare gains to having the central bank respond to the term premium, eg., including the term premium in the Taylor rule. Third, a policy that directly targets the term premium sterilizes the real economy from shocks originating in the financial sector. A term premium peg can have significant welfare effects.
Topics
Lending and access to credit
Econometrics modeling and forecasting
10.09.2014ISSN 2573-7953 WP 14-19DOI 10.26509/frbc-wp-201419
Keywords agency costs, cge models, optimal contracting
JEL Classification Codes C68, E44, E61

Working Papers of the Federal Reserve Bank of Cleveland are preliminary materials circulated to stimulate discussion and critical comment on research in progress. They may not have been subject to the formal editorial review accorded official Federal Reserve Bank of Cleveland publications. The views expressed in this paper are those of the authors and do not represent the views of the Federal Reserve Bank of Cleveland or the Federal Reserve System.

Suggested Citation

Carlstrom, Charles T., Timothy S. Fuerst, and Matthius Paustian. 2014. “Targeting Long Rates in a Model with Segmented Markets.” Federal Reserve Bank of Cleveland, Working Paper No. 14-19. https://doi.org/10.26509/frbc-wp-201419