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Do term premiums matter? Transmission via exchange rate dynamics

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  • Katagiri, Mitsuru
  • Takahashi, Koji

Abstract

The macroeconomic effect of term premiums is a controversial issue both theoretically and quantitatively. In this paper, we explore the possibility that term premiums affect inflation and the real economy via exchange rate dynamics. For this purpose, we construct a small open economy model with limited asset market participation, focusing on the empirical observation that uncovered interest parity holds better for longer-term interest rate differentials. A quantitative exercise using Japanese and U.S. data shows that changes in term premiums, particularly those made by the central bank's bond purchases, have sizable effects on Japanese inflation rates via exchange rate dynamics.

Suggested Citation

  • Katagiri, Mitsuru & Takahashi, Koji, 2023. "Do term premiums matter? Transmission via exchange rate dynamics," Journal of International Money and Finance, Elsevier, vol. 139(C).
    • Handle: RePEc:eee:jimfin:v:139:y:2023:i:c:s0261560623001481
    DOI: 10.1016/j.jimonfin.2023.102947
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    More about this item

    Keywords

    Term premium; Uncovered interest rate parity; Quantitative easing;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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