Negative Bond Term Premia - A New Challenge for Polish Conventional Monetary Policy

While the euro area ponders another round of quantitative easing, Poland's monetary policy remains stubbornly conventional. Although the NBP's Monetary Policy Council has delivered a monetary easing cycle, policy rates in Poland remain above those of many peers, most notably the largest trading partner – the euro area. In this paper we seek to explain the motives behind the NBP's strategy, presenting the views on price stability and economic growth developments that shape short-term rate policy. In addition, we argue that – amid exceptionally low inflation and the euro area's relaxed monetary policy – the range of interest rates in a small open economy is not fully dependent on the domestic level of short-term rates. More specifically, using a formal term structure model, we show that Poland's bond term premium has been driven to negative levels by yield-hungry foreign investors in the context of a restricted supply of short-term Treasury paper and reduced uncertainty about the future path of short-term rates. As a result, long-term yields have fallen below the expected path of future short-term rates, adding to the monetary stimulus even as policy rates remain unchanged.Full Publication: 'http://ssrn.com/abstract=2870167' Inflation Mechanisms, Expectations and Monetary Policy