Michael Bauer
Research Advisor
Financial Research
Monetary economics, Asset pricing, Econometrics
CV (pdf, 193.91 kb) | Bio (pdf, 162.02 kb)
Profiles: Google Scholar | RePEc | SSRN | LinkedIn | Personal website
Working Papers
A Reassessment of Monetary Policy Surprises and High-Frequency Identification
Working Paper | with Swanson | April 2022
abstract (+)High-frequency changes in interest rates around FOMC announcements are an important tool for identifying the effects of monetary policy on asset prices and the macroeconomy. However, some recent studies have questioned both the exogeneity and the relevance of these monetary policy surprises as instruments, especially for estimating the macroeconomic effects of monetary policy shocks. For example, monetary policy surprises are correlated with macroeconomic and financial data that is publicly available prior to the FOMC announcement. We address these concerns in two ways: First, we expand the set of monetary policy announcements to include speeches by the Fed Chair, which doubles the number and importance of announcements; Second, we explain the predictability of the monetary policy surprises in terms of the “Fed response to news” channel of Bauer and Swanson (2021) and account for it by orthogonalizing the surprises with respect to macroeconomic and financial data that pre-date the announcement. Our subsequent reassessment of the effects of monetary policy yields two key results: First, estimates of the high-frequency effects on asset prices are largely unchanged; Second, estimates of the effects on the macroeconomy are substantially larger and more significant than what previous studies using high-frequency data have typically found.
Interest Rate Skewness and Biased Beliefs
Working Paper | with Chernov | December 2021
abstract (+)The conditional skewness of Treasury yields is an important indicator of the risks to the macroeconomic outlook. Positive skewness signals upside risk to interest rates during periods of accommodative monetary policy and an upward-sloping yield curve, and vice versa. Skewness has substantial predictive power for future bond excess returns, high-frequency interest rate changes around FOMC announcements, and survey forecast errors for interest rates. The estimated expectational errors, or biases in beliefs, are quantitatively important for statistical bond risk premia. These findings are consistent with a heterogeneous-beliefs model where one of the agents is wrong about consumption growth.
An Alternative Explanation for the “Fed Information Effect”
2020-06 | with Swanson | September 2021
abstract (+)High-frequency changes in interest rates around FOMC announcements are a standard method of measuring monetary policy shocks. However, some recent studies have documented puzzling effects of these shocks on private-sector forecasts of GDP, unemployment, or inflation that are opposite in sign to what standard macroeconomic models would predict. This evidence has been viewed as supportive of a “Fed information effect” channel of monetary policy, whereby an FOMC tightening (easing) communicates that the economy is stronger (weaker) than the public had expected. We show that these empirical results are also consistent with a “Fed response to news” channel, in which incoming, publicly available economic news causes both the Fed to change monetary policy and the private sector to revise its forecasts. We provide substantial new evidence that distinguishes between these two channels and strongly favors the latter; for example, (i) regressions that include the previously omitted public economic news, (ii) a new survey that we conduct of Blue Chip forecasters, and (iii) high-frequency financial market responses to FOMC announcements all indicate that the Fed and private sector are simply responding to the same public news, and that there is little if any role for a “Fed information effect”.
Published Articles (Refereed Journals and Volumes)
The Rising Cost of Climate Change: Evidence from the Bond Market
Forthcoming in The Review of Economics and Statistics | with Rudebusch
abstract (+)Social discount rates (SDRs) are crucial for evaluating the costs of climate change. We show that the fundamental anchor for market-based SDRs is the equilibrium or steady-state real interest rate. Empirical interest rate models that allow for shifts in this equilibrium real rate find that it has declined notably since the 1990s, and this decline implies that the entire term structure of SDRs has shifted lower as well. Accounting for this new normal of persistently lower interest rates substantially boosts estimates of the social cost of carbon and supports a climate policy with stronger carbon mitigation strategies.
Market-Based Monetary Policy Uncertainty
The Economic Journal 132(644), May 2022, 1290–1308 | with Lakdawala and Mueller
abstract (+)Uncertainty about future policy rates plays a crucial role for the transmission of monetary policy to financial markets. We demonstrate this using event studies of FOMC announcements and a new model-free uncertainty measure based on derivatives. Over the “FOMC uncertainty cycle” announcements systematically resolve uncertainty, which then gradually ramps up again over the subsequent two weeks. Changes in monetary policy uncertainty around FOMC announcements-often due to new forward guidance-have pronounced effects on asset prices that are distinct from the effects of conventional policy surprises. Furthermore, the level of uncertainty determines the magnitude of the financial market reaction to surprises about the path of policy rates.
Interest Rates Under Falling Stars
American Economic Review 110(5), May 2020, 1316-1354 | with Rudebusch
abstract (+)Macro-finance theory implies that trend inflation and the equilibrium real interest rate are fundamental determinants of the yield curve. However, empirical models of the terms structure of interest rates generally assume that these fundamentals are constant. We show that accounting for time variation in these underlying long-run trends is crucial for understanding the dynamics of Treasury yields and predicting excess bond returns. We introduce a new arbitrage-free model that captures the key role that long-run trends play for interest rates. The model also provides new, more plausible estimates of the term premium and accurate out-of-sample yield forecasts.
Restrictions on Risk Prices in Dynamic Term Structure Models
Journal of Business & Economic Statistics 36(2), 2018, 196-211
abstract (+)Restrictions on the risk-pricing in dynamic term structure models (DTSMs) tighten the link between cross-sectional and time-series variation of interest rates, and make absence of arbitrage useful for inference about expectations. This paper presents a new econometric framework for estimation of affine Gaussian DTSMs under restrictions on risk prices, which addresses the issues of a large model space and of model uncertainty using a Bayesian approach. A simulation study demonstrates the good performance of the proposed method. Data for U.S. Treasury yields calls for tight restrictions on risk pricing: only level risk is priced, and only changes in the slope affect term premia. Incorporating the restrictions changes the model-implied short-rate expectations and term premia. Interest rate persistence is higher than in a maximally-flexible model, hence expectations of future short rates are more variable–restrictions on risk prices help resolve the puzzle of implausibly stable short-rate expectations in this literature. Consistent with survey evidence and conventional macro wisdom, restricted models attribute a large share of the secular decline in long-term interest rates to expectations of future nominal short rates.
supplement (+) wp11-03bk.pdf – Working Paper
rrp_appendix.pdf – Online Appendix
bauer_rrp_replication.zip – Code and Data for Replication
rrp_appendix.pdf – Online Appendix
bauer_rrp_replication.zip – Code and Data for Replication
Robust Bond Risk Premia
Review of Financial Studies, 2017 | with Hamilton
abstract (+)A consensus has recently emerged that variables beyond the level,
slope, and curvature of the yield curve can help predict bond
returns. This paper shows that the statistical tests underlying this
evidence are subject to serious small-sample distortions. We propose
more robust tests, including a novel bootstrap procedure
specifically designed to test the spanning hypothesis. We revisit the
analysis in six published studies and find that the evidence against
the spanning hypothesis is much weaker than it originally
appeared. Our results pose a serious challenge to the prevailing
consensus.
supplement (+)
Resolving the Spanning Puzzle in Macro-Finance Term Structure Models
Review of Finance 21, 2017, 511-553 | with Rudebusch
abstract (+)Most existing macro-finance term structure models (MTSMs) appear incompatible with regression evidence of unspanned macro risk. This “spanning puzzle” appears to invalidate those models in favor of new unspanned MTSMs. However, our empirical analysis supports the previous spanned models. Using simulations to investigate the spanning implications of MTSMs, we show that a canonical spanned model is consistent with the regression evidence; thus, we resolve the spanning puzzle. In addition, direct likelihood-ratio tests find that the knife-edge restrictions of unspanned models are rejected with high statistical significance, though these restrictions have only small effects on cross-sectional fit and estimated term premia.
supplement (+) wp2015-01.pdf – Working Paper
Monetary Policy Expectations at the Zero Lower Bound
Journal of Money, Credit and Banking 48, 2016, 7 | with Rudebusch
abstract (+)We show that conventional dynamic term structure models (DTSMs) estimated on recent U.S. data severely violate the zero lower bound (ZLB) on nominal interest rates and deliver poor forecasts of future short rates. In contrast, shadow-rate DTSMs account for the ZLB by construction, capture the resulting distributional asymmetry of future short rates, and achieve good forecast performance. These models provide more accurate estimates of the most likely path for future monetary policy—including the timing of policy liftoff from the ZLB and the pace of subsequent policy tightening. We also demonstrate the benefits of including macroeconomic factors in a shadow-rate DTSM when yields are constrained near the ZLB.
supplement (+) wp2013-18.pdf – Working Paper
bauer_rudebusch_zlb_replication.zip – Data and code for replication
shadow_rates.csv – Estimated shadow rates
bauer_rudebusch_zlb_replication.zip – Data and code for replication
shadow_rates.csv – Estimated shadow rates
Nominal Interest Rates and the News
Journal of Money, Credit and Banking 47 (2-3), 2015, 295-331
abstract (+)This paper provides new estimates of the impact of monetary policy actions and macroeconomic news on the term structure of nominal interest rates. The key novelty is to parsimoniously capture the impact of news on all interest rates using a simple no-arbitrage model. The different types of news are analyzed in a common framework by recognizing their heterogeneity, which allows for a systematic comparison of their effects. This approach leads to novel empirical findings: First, monetary policy causes a substantial amount of volatility in both short-term and long-term interest rates. Second, macroeconomic data surprises have small and mostly insignificant effects on the long end of the term structure. Third, the term-structure response to macroeconomic news is consistent with considerable interest-rate smoothing by the Federal Reserve. Fourth, monetary policy surprises are multidimensional while macroeconomic surprises are one-dimensional.
supplement (+)
Inflation Expectations and the News
International Journal of Central Banking 11 (2), 2015, 1-40
abstract (+)This paper provides new evidence on the importance of inflation expectations for variation in nominal interest rates, based on both market-based and survey-based measures of inflation expectations. Using the information in TIPS breakeven rates and inflation swap rates, I document that movements in inflation compensation are important for explaining variation in long-term nominal interest rates, both unconditionally as well as conditionally on macroeconomic data surprises. Daily changes in inflation compensation and changes in long-term nominal rates generally display a close statistical relationship. The sensitivity of inflation compensation to macroeconomic data surprises is substantial, and it explains a sizable share of the macro response of nominal rates. The paper also documents that survey expectations of inflation exhibit significant comovement with variation in nominal interest rates, as well as significant responses to macroeconomic news.
supplement (+) wp2014-09.pdf – Working Paper
The Signaling Channel for Federal Reserve Bond Purchases
International Journal of Central Banking 10(3), September 2014, 233-289 | with Rudebusch
abstract (+)Previous research has emphasized the portfolio balance effects of Federal Reserve bond purchases, in which a reduced bond supply lowers term premia. In contrast, we find that such purchases have important signaling effects that lower expected future short-term interest rates. Our evidence comes from a model-free analysis and from dynamic term structure models
that decompose declines in yields following Federal Reserve announcements into changes in risk premia and expected short
rates. To overcome problems in measuring term premia, we consider bias-corrected model estimation and restricted risk price estimation. In comparison with other studies, our estimates of signaling effects are larger in magnitude and statistical significance.
International Channels of the Fed’s Unconventional Monetary Policy
Journal of International Money and Finance 44, June 2014, 24-46 | with Neely
abstract (+)Previous research has established that the Federal Reserve’s large scale asset purchases (LSAPs) significantly influenced international bond yields. We use dynamic term structure models to uncover to what extent signaling and portfolio balance channels caused these declines. For the U.S. and Canada, the evidence supports the view that LSAPs had substantial signaling effects. For Australian and German yields, signaling effects were present but likely more moderate, and portfolio balance effects appear to have played a relatively larger role than in the U.S. and Canada. Portfolio balance effects were small for Japanese yields and signaling effects basically nonexistent. These findings about LSAP channels are consistent with predictions based on interest rate dynamics during normal times: Signaling effects tend to be large for countries with strong yield responses to conventional U.S. monetary policy surprises, and portfolio balance effects are consistent with the degree of substitutability across international bonds, as measured by the covariance between foreign and U.S. bond returns.
Term Premia and Inflation Uncertainty: Empirical Evidence from an International Panel Dataset: Comment
American Economic Review 104(1), January 2014, 323-337 | with Rudebusch and Wu
abstract (+)Term premia implied by maximum likelihood estimates of affine term structure models are misleading because of small-sample bias. We show that accounting for this bias alters the conclusions about the trend, cycle, and macroeconomic determinants of the term premia estimated in Wright (2011). His term premium estimates are essentially acyclical, and often just parallel the secular trend in long-term interest rates. In contrast, bias-corrected term premia show pronounced countercyclical behavior, consistent with theoretical and empirical arguments about movements in risk premia.
supplement (+)
Correcting Estimation Bias in Dynamic Term Structure Models
Journal of Business and Economic Statistics 30(3), July 2012, 454-467 | with Rudebusch and Wu
abstract (+)The affine dynamic term structure model (DTSM) is the canonical empirical finance representation of the yield curve. However, the possibility that DTSM estimates may be distorted by small-sample bias has been largely ignored. We show that conventional estimates of DTSM coefficients are indeed severely biased, and this bias results in misleading estimates of expected future short-term interest rates and of long-maturity term premia. We provide a variety of bias-corrected estimates of affine DTSMs, both for maximally-flexible and over-identified specifications. Our estimates imply short rate expectations and term premia that are more plausible from a macro-finance perspective.
supplement (+) wp11-12bk.pdf – Working paper
brw_replication.zip – Data and code for replication
brw_appendix.pdf – Online appendix
brw_replication.zip – Data and code for replication
brw_appendix.pdf – Online appendix
FRBSF Publications
Current Recession Risk According to the Yield Curve
Economic Letter 2022-11 | May 9, 2022 | with Mertens
Climate Change Costs Rise as Interest Rates Fall
Economic Letter 2021-28 | October 20, 2021 | with Rudebusch
Zero Lower Bound Risk according to Option Prices
Economic Letter 2019-24 | September 23, 2019 | with Mertens
San Francisco Fed Joins CEPR Global Research Network
SF Fed Blog | Sep 2019
Did the Yield Curve Flip? Will the Economy Dip?
SF Fed Blog | Feb 2019 | with Mertens
Information in the Yield Curve about Future Recessions
Economic Letter 2018-20 | August 27, 2018 | with Mertens
Economic Forecasts with the Yield Curve
Economic Letter 2018-07 | March 5, 2018 | with Mertens
A New Conundrum in the Bond Market
Economic Letter 2017-34 | November 20, 2017
Bridging the Gap: Forecasting Interest Rates with Macro Trends
Economic Letter 2017-21 | July 31, 2017
Why Are Long-Term Interest Rates So Low?
Economic Letter 2016-36 | December 5, 2016 | with Rudebusch
Do Macro Variables Help Forecast Interest Rates?
Economic Letter 2016-20 | June 27, 2016 | with Hamilton
Can We Rely on Market-Based Inflation Forecasts?
Economic Letter 2015-30 | September 21, 2015 | with McCarthy
Optimal Policy and Market-Based Expectations
Economic Letter 2015-12 | April 13, 2015 | with Rudebusch
Options-Based Expecations of Future Policy Rates
Economic Letter 2014-29 | September 29, 2014
Financial Market Outlook for Inflation
Economic Letter 2014-14 | May 12, 2014 | with Christensen
Expectations for Monetary Policy Liftoff
Economic Letter 2013-34 | November 18, 2013 | with Rudebusch
What Caused the Decline in Long-term Yields?
Economic Letter 2013-19 | July 8, 2013 | with Rudebusch
Monetary Policy and Interest Rate Uncertainty
Economic Letter 2012-38 | December 24, 2012
Fed Asset Buying and Private Borrowing Rates
Economic Letter 2012-16 | May 21, 2012
Signals from Unconventional Monetary Policy
Economic Letter 2011-36 | November 21, 2011 | with Rudebusch
What Moves the Interest Rate Term Structure?
Economic Letter 2011-34 | November 7, 2011
