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Financial frictions, monetary policy, and the term premium

Published online by Cambridge University Press:  14 March 2025

Sungjun Huh  and
Insu Kim
Sungjun Huh
Affiliation:
Department of Economics, Konkuk University, Gwangjin-gu, Seoul, Republic of Korea
Insu Kim*
Affiliation:
Department of Economics, Jeonbuk National University, Jeonju-si, Jeollabuk-do, Republic of Korea
*
Corresponding author: Insu Kim; Email: insu.kim@jbnu.ac.kr
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Abstract

This study investigates the contribution of financial frictions in term premiums on long-term bonds within a production economy. We consider a New Keynesian model, featuring an agency problem between financial intermediaries and their private creditors and generalized recursive preferences. The model predicts that financial frictions that amplify the impact of structural shocks on key macroeconomic variables increase term premiums under our baseline calibration. Furthermore, financial frictions produce a larger term premium when monetary policy is geared toward output over inflation stability. The novel mechanism that financial frictions increase term premiums are associated with the bank balance sheet channel of monetary policy.

Keywords

Financial frictionsepstein-zin preferencesbond premiuminflation riskmoral hazardE32E44G12
Type
Articles
Information
Macroeconomic Dynamics , Volume 29 , 2025 , e82
Copyright
© The Author(s), 2025. Published by Cambridge University Press

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