Bond Premia And Monetary Policy Over 40 Years

We identify stylised facts in the relationship between macroeconomic conditions and the evolution of yields and yield premia over 40 years of U.S. data. In order to constrain our estimates, we ask our model to fit not just yields and macro data, but also survey information on inflation and interest rate expectations. Monetary policy appears to be the main determinant of the evolution of risk premia on 10-year nominal bonds, through changes in the perceived inflation target of the Federal Reserve. Any increase in the target, which needs to be filtered by economic agents, is slowly and persistently reflected into an increase of the 10-year premium. An increase in the perceived target also has the indirect effect of making risk premia more sensitive to the cycle. Estimated premia are therefore highest during the early 80s recession, which took place when the disinflationary process was not yet completed.