Martin Ellison

(Oxford University)

will give a presentation on 

Liability-Driven Investors and Monetary Transmission

Abstract

The ability of monetary policy to influence the term structure of interest rates and the macroeconomy depends on the extent to which financial market participants prefer to hold bonds of different maturities. We introduce such preferred-habitat demand in a fully-specified dynamic stochastic general equilibrium model of the macroeconomy where the term structure is arbitrage-free. The source of preferred habitat demand is an insurance fund that issues annuities and adopts a liability-driven investment strategy to minimise the duration risk on its balance sheet. The behaviour of the insurance fund implies a liability-driven demand function that is upward-sloping in bond prices and downward-sloping in bond yields, especially when interest rates are low. This supports the operation of a recruitment channel at low interest rates, whereby long-term interest rates react strongly to short-term policy rates or unconventional policy because of complementary changes in term premia induced by liability-driven demand. The strong reaction and enhanced monetary transmission extend to inflation and output in general equilibrium.

Joint with Giacomo Carboni (European central Bank), Artur Doshchyn (University of Bristol). 

Seminar co-organized by CORE.