Money market rates and implied CCAPM rates: some international evidence

This paper examines the transmission mechanism of monetary policy in New Neoclassical Synthesis (NNS) models, using data from six of the G7 countries. NNS models equate the instrument of monetary policy to the interest rate implied by the consumption Euler equation. The key result is that an increase in the nominal interest rate leads to a fall in the implied Euler equation rate. Incorporating habit still yields the same result. The findings have a serious implication for the transmission mechanism of monetary policy since movements of money market rates, consumption and inflation cannot be reconciled through the consumption Euler equation, irrespective of how the rest of the NNS model is specified.