Decomposing real and nominal yield curves

Inflation-indexed and nominal yield curves capture investors׳ expectations of real short rates and inflation as well as their required compensation for bearing liquidity, inflation, and real interest rate risk. We estimate an affine term structure model that allows us to decompose real and nominal bond yields into these components and use the model to study the transmission of monetary policy. The model decompositions imply that the Federal Reserve׳s announcements of LSAPs lowered yields primarily by reducing real term premia. Changes in real term premia also account for the strong response of long-term real forward rates to federal funds rate surprises.