Evidence of Macroeconomic Shocks on the European Central Bank Policy Reaction Function and the European Term Structure of Interest Rates

This work is rather an empirical study about the ECB policy reaction function (PRF) as well as the effects that macroeconomic data releases have on the term structure of interest rates. The study shows that even though forecasts on the policy rate and the term structure of interest rates improve by increasing the number of macroeconomic variables in the model, it also shows that only a handful of them are significant. This paper also shows an alternative estimate of the empirical reaction function without smoothing. The empirical results show also that macroeconomic releases have a term structure effect and that some macroeconomic data would have an influence on the short end of the curve and other macroeconomic releases would have an influence rather on the longer end or both. Subsequently, some macroeconomic releases would have contradicting effects which depends on the maturities. Hence, some releases would have an increasing (positive) effect on the yields in the lower end of the curve and a decreasing (negative) effect in the longer end. Strikingly, results show a high degree of correlation for the models and variables involved and that yields in the term structure of interest appear to be statistically co-integrated, thus all interest rates converge to the same level after the shock dies away