The Political Economy of the Yield Curve

This paper proposes a novel method to recover the market's beliefs about the Fed's monetary policy by using the responses of interest rates to economic news. We investigate the differential impact of news over time showing that the impact of this information is time varying, and that the importance of the housing and labor markets has sharply increased after the crisis. We follow a difference-in-difference estimation procedure to test for the presence of political constraints in the U.S., employing as control group the response of the European swap rates to macroeconomic announcements. We provide strong evidence that after the crisis of 2007, the Federal Reserve has been subject to the political pressure exerted by the Congress.