Authors: Mohamed Z. M. Aazim
The question of how monetary policy (MP) translates across the yield curve (YC) is at the forefront of many recent policy debates. MP targets the very short end of the YC although real economic activity is largely influenced by medium to longterm market interest rates. Given efficient market conditions, conventional wisdom asserts that changes to the monetary policy instrument leads to an immediate change in market interest rates and bond prices distributed over all maturities; yet evidence supporting this view remains elusive. Using the expectations hypothesis (EH) as a benchmark, an empirical analysis of daily yield rates for the Japanese money and government bond markets for the period 2001- 2006 where monetary policy regime was quantity targeting (QT) provides evidence for segmentation over the YC. The EH receives little support and the observed concentration of impact suggests highly segmented market niches. The empirical findings invite attention of monetary policy makers to the financial system and its structural impediments, especially in an environment of economic uncertainty, low market confidence, and a binding interest rate floor.
Keywords: Monetary policy regimes; expectation hypothesis; segmented market hypothesis; yield curve; and term structure of interest rates