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Title: Term premium, credit risk premium, and monetary policy Authors:  Andrea Ajello - Board of Governors of the Federal Reserve System (United States) [presenting]
Abstract: The aim is to build and calibrate a New-Keynesian DSGE model with Epstein-Zin preferences and financial frictions in the shape of multi-period nominal defaultable debt, to fit U.S. data moments. We solve the model using higher-order perturbations and show that credit frictions can significantly increase the size and volatility of the nominal and real Treasury term premium through the interaction of preferences sensitive to long-run risk, and amplification of the economy's response to TFP shocks. Our analysis suggests that introducing multi-period defaultable debt contracts helps fit the cyclical properties of macroeconomic and financial variables, including credit spreads, credit risk premia and leverage ratios together with the main features of the \emph{default-free} term structure of interest rates. Model simulations show that unexpected monetary policy shocks have small effects on term and credit-risk premia dynamics, while the systematic component of monetary policy has sizable implications for the average and volatility of risk compensation. In particular, monetary policy that responds more to inflation fluctuations relative to output reduces the average and the volatility of nominal term premia, while increasing the average and volatility of credit risk premia, by affecting the mix of inflation volatility and debt-deflation risk in the economy.