The expectations hypothesis is a theory of the term structure of interest rates that describes a
conventional view of the transmission mechanism of monetary policy. According to the expectations hypothesis, bond rates are related to current and expected movements in the policy-controlled rate.  However, empirical rejections of the expectations hypothesis are commonplace and lead many to question this description of policy transmission. This paper argues that failure to account for imperfect policy credibility may explain empirical rejections. Empirical rejections may occur even when changing anticipations of future short rates are the primary source of variation in bond rates and the standard term structure transmission channel remains valid.

JEL Classification:  E43, E52, E47

Key words:  Changepoints, expectations hypothesis, nonstationary inflation, shifting endpoint

Sharon Kozicki is an assistant vice president and economist at the Federal Reserve Bank of Kansas City. P.A. Tinsley is a lecturer on the Faculty of Economics and Politics at the University of Cambridge, Cambridge, England. The authors are grateful for comments from Mark Gertler, session participants at the 2001 AEA meetings, and seminar participants at the Federal Reserve Bank of Kansas City and the University of Missouri-Columbia. Special thanks go to Jeff Fuhrer who provided code to estimate forward-looking macro models using AIM. The views expressed in this paper are those of the authors and do not necessarily represent the views of the Federal Reserve Bank of Kansas City or the Federal Reserve System

Kozicki E-mail: sharon.kozicki@kc.frb.org
Tinsley E-mail: ptinsley@econ.cam.ac.uk