MONEY GROWTH AND THE TERM STRUCTURE OF INTEREST RATES (YIELD CURVE, ANTICIPATED, UNANTICIPATED)

This paper has investigated the relationship between money growth and the term structure of interest rates. Theory suggests that, in addition to the direct (negative) effect on interest rates of a liquidity effect, there will be subsequent longer run effects of increased income growth and inflation. These longer run effects are theorized to put upward pressure at all maturities such that the yield curve may eventually rise above its original position. In addition, recent literature has noted the importance of distinguishing between the unanticipated and anticipated components of these effects.; The procedure used to investigate these effects is to express representative yields from the Treasury yield curve--three-month, three-year and twenty-year obligations--as functions of the unanticipated and anticipated components of money growth, real income growth and inflation. The sample period investigated is 1953:1-1979:4, using quarterly data. A two step estimation procedure is employed, whereby forecasting equations are estimated and the residual and fitted values are retained for use as unanticipated and anticipated explanatory variables in each of the interest rate equations.; The results show that both unanticipated and anticipated money growth shift the yield curve downward and with greater strength at the short end.; Both unanticipated and anticipated real income growth generate upward pressure on the yield curve. However, these effects are not of sufficient magnitude to offset the strength of the liquidity effect.; It is the strength of anticipated inflation that eventually causes the yield curve to rise above its original position. Lastly, the effects of unanticipated inflation are never significant. This result is probably due to the potentially offsetting supply shock effects for which unanticipated inflation may be proxying.