Interest rate term structure and the Chinese fiscal policy: a mixed frequency term structure approach

Abstract

We specify a mixed-frequency Nelson–Siegel term structure (MF-NS) model with fiscal policy information to investigate the influence of fiscal policy on interest rate term structure. This paper finds the following results: First, fiscal policy information can significantly improve both the in-sample fitting and out-of-sample predictions of the Chinese yield curve. More importantly, compared with short-term bonds, the fiscal variable has a greater contribution to long-term bonds. Second, the response of the level factor of the yield curve to monetary impulse is positive, while the response to fiscal surprise is negative. Furthermore, we suggest that monetary policy shows an inflation expectation effect for the level factor. However, fiscal policy shocks on the level factor via the wealth effect. Finally, fiscal policy account for the larger forecast variance of yield curve than monetary policy does in the short forecast horizon. Meanwhile, this paper further shows that fiscal policy has a greater contribution to forecast variance of long-term yield than short-term yield.

Keywords:

• Term structure
• fiscal policy
• mixed frequency
• forecast

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1 The value of $P$ indicates the number of higher frequencies in one period of low frequency. The value of $P$ is affected by the type of data, such as flow data or stock data.

Additional information

Funding

This study was funded by National Office for Philosophy and Social Sciences; the National Natural Science Foundation of China (no.71701165, 71950010); and the National Social Science Foundation of China (no.20BJY255, no.20&ZD081).

Notes on contributors

Yuhuang Shang

Yuhuang Shang is at Institute of Chinese Financial Studies, Southwestern University of Finance and Economics, Chengdu, China. Research interest: term structure; mixed frequency modeling.

Xuyang Zhang

Xuyang Zhang is at Institute of Chinese Financial Studies, Southwestern University of Finance and Economics, Chengdu, China. Research interest: monetary policy.

Qing Wang

Qing Wang is at Institute of Chinese Financial Studies, Southwestern University of Finance and Economics, Chengdu, China. Research interest: macro-finance; monetary policy.