Interpreting the Movements in Short-Term Interest Rates

This article uses modern asset pricing theory to examine the behavior of short-term nominal interest rates over the past twenty-five years. The analysis investigates whether variation in the stochastic behavior of consumption growth and inflation can explain movements in the rate of interest. The model estimated allows for taste shocks to utility. The authors' results reveal that much of the month-to-month movement in nominal interest rates reflects changes in the real rate and the risk premia in addition to inflationary expectations.