Bond Markets and Monetary Policy

Since the early 1990's, and until the 2008 financial crisis, the main policy tool of the FOMC has been a nominal interest rate target. This paper surveys an extensive literature that studies the link between monetary policy and the dynamics of bond yields. This literature uses ‘high-frequency' identification around FOMC announcements to measure shocks to market participant's expectations about the current and future stance of monetary policy. Summarising the literature, we argue monetary policy affects yields at all maturities because of two types of shock: (i) shocks to the target rate; and (ii) shocks to the future path of the monetary policy. Interestingly, compelling evidence shows that path shocks are not linked to changes in expected inflation but linked to two alternative channels: an information and a (real) risk premium channel. We present novel empirical evidence in support of a risk premium channel