Time-varying response of treasury yields to monetary policy shocks. Evidence from the Tunisian bond market

Author:Lassaâd Mbarek, Hardik A. Marfatia, Sonja Juko
Position:Department of Monetary Policy, Central Bank of Tunisia, Tunis, Tunisia
Pages:422-442
SUMMARY

Purpose This paper aims to examine the Treasury bond yields response to monetary policy shocks in Tunisia under a heterogeneous economic environment. Design/methodology/approach Using a traditional fixed coefficient model, the impact of monetary policy changes on the term structure of interest rates for the whole period from January 2006 to December 2016 is estimated first. Then the stability of... (see full summary)

 
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Time-varying response of
treasury yields to monetary
policy shocks
Evidence from the Tunisian bond market
Lassaâd Mbarek
Department of Monetary Policy, Central Bank of Tunisia, Tunis, Tunisia
Hardik A. Marfatia
Northeastern Illinois University, Chicago, Illinois, USA, and
Sonja Juko
Deutsche Bundesbank, Frankfurt am Main, Germany
Abstract
Purpose This paper aims to examine the Treasury bond yields response to monetary policy shocks in
Tunisiaunder a heterogeneous economic environment.
Design/methodology/approach Using a traditional xed coefcient model, the impact of
monetary policy changes on the term structure of interest rates for the whole period from January 2006
to December 2016 is estimated rst. Then the stability of this relationship by distinguishing two sub-
periods around the revolution of January 2011 is studies. To investigate how the relationship between
the monetary policy and the Treasury yield curve evolves over time, a time-varying parameter modelis
estimated.
Findings The results show that the impactof monetary policy is more pronounced at the short end of the
yield curve relative to the longer end. Furthermore, this impact declines signicantly across all maturities
following the revolution and exhibits widetime variation. This evidence supports the negative inuence of
high levels of uncertainty on monetary policy effectiveness and highlights the desirability of more active
monetarypolicy, especially in turbulent environment.
Research limitations/implications The impact of uncertainty on the effectiveness of monetary
policy shocks needs to be explored further in future research to understand the structural sources of
uncertaintyand their dynamic interactions with monetary policyand risk aversion in asset markets.
Practical implications A more active role of the central bank to inuence the yield curve mainly
through Treasury bondpurchases covering medium and long maturities maybe warranted. Communication
also needs to be reinforcedto ensure predictability of the monetary policy stance.
Originality/value This paper extendsthe empirical literature on the pass-throughof monetary policy to
interest rates for an emerging country in contextof transition by estimating a state-space model to test the
time-varying behavior and examine the inuence of increased economic uncertainty on monetary policy
effectiveness.
Keywords Uncertainty, Monetary policy, Time-varying parameter model, Yield curve
Paper type Research paper
This work was sponsored by the Economic Research Forum (ERF) and has beneted from both
nancial and intellectual support. The contents and recommendations do not necessarily reect
ERFs views.
JFRC
27,4
422
Received7 November 2018
Revised1 February 2019
Accepted29 March 2019
Journalof Financial Regulation
andCompliance
Vol.27 No. 4, 2019
pp. 422-442
© Emerald Publishing Limited
1358-1988
DOI 10.1108/JFRC-11-2018-0146
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1358-1988.htm
1. Introduction
Assessing the effect of monetary policy on the term structure of interest rates is a key
challenge and the subject of an intense debate among policymakers and academics. It has
attracted great attention in the literature especially in the aftermath of the recent nancial
crisis. In many countries, steeringthe short end of the yield curve is the operational target of
monetary policy implementation. This, in turn, can affect long-term interest rates via the
expectation hypothesis of the term structure of interest rates. Monetary authority can
control the short-term interest rates the most, as it supplies reserves to the banking system
and can estimate the demand for overnight funds, which are largely driven by reserve
requirements and changes in autonomous factors of liquidity. Meanwhile, the aggregate
demand in an economy depends primarily on long-term interest rates, which represent part
of the cost of borrowing forhouseholds and the cost of capital for rms.
As suggested by Benito et al. (2007), the uncollateralized overnight rate in the interbank
market is crucial for signaling monetary policy stance, marking the rst step of the
monetary policy transmissionprocess, and allows central banks to inuence the behavior of
longer-term interest rates. In the same vein, Bernanke and Blinder (1992);Estrella and
Hardouvelis (1991) and Mishkin (1990), among others, argued that monetary policy is a
major factor in explaining the term structure of interest rates[1]. Monetary policy actions
such as policy rate changes often contain new information relevant to nancial markets. In
addition to the overnight rate, the central bank can affect long-term rates by modifying
expectations of future short-term rates. The dynamics of interest rates across the maturity
spectrum depend also on various underlying factors, such as the prospects of economic
growth and expectations regarding ination and monetary policy, as well as risk
preferences. Interest rates are subject to constant up and down movements, as market
participants receivenew information about these factors.
In the early 1990s, several centralbanks intervened on long-term bond markets (the Fed,
the Bundesbank, some Latin American central banks [...]). In contrast, over the past
20 years, intervening at the short end of the yield curve in orderto inuence long-term rates
and aggregate demand has become thegeneral practice. The severity of the nancial crisis
of 2008 led many central banks in advanced economies to cut their policyrates to near zero
to alleviate nancial marketdistress, boost output and stabilize ination. In such a situation,
major central banks resorted to unconventional monetary policy tools, such as large-scale
asset purchases (quantitative easing) directly aimed at targeting longer-term rates,
communication regarding the futurepath of the policy rate (forward guidance) and recently
negative interest rates. Unconventional tools may be seen as a substitute for conventional
monetary policy when policy rates are close to the zero lower bound. Bayoumi et al. (2014)
conjectured that central banks wouldbe less constrained by hitting the zero lower bound if
unconventional monetary policytools were as effective as the short-term policy rate. Santor
and Suchanek (2016) stated that the unconventional is increasingly becoming conventional,
and unconventional monetary policies have established themselves as an integral part
of any modern central banks tool kit. As advocated by Pain et al. (2014), monetary policy
actions undertaken were largely successful in coping with nancial market distress, but
their effects on ination and growth were limited. Bloom (2014) noticed that the
effectiveness of monetary policy may vary with respect to the degree of uncertainty
throughout a nancialcrisis.
The interest rate channel plays a key role in the transmission of monetary policy to the
real economy. Hence, the question addressed in this study is about the pass through of
changes in central bank policy rate to market rates starting from short maturities and
moving to longer maturitiesthrough the yield curve.
Treasury
yields
423

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