Shock and awe? Bond yield responses to domestic monetary policy in a small-open economy

Abstract

We use Switzerland as a case study to assess the channels through which the domestic monetary policy of a small-open economy affects benchmark interest rates. Monetary-policy shocks are identified via changes in expectations on announcement days. We show that the shocks have a persistent effect on long-term government bond yields because they influence expectations about future short-term rates (the so-called signaling channel). By contrast, monetary-policy shocks have little impact on the term premium component of the bond yields (portfolio rebalancing channel). The full effect of the monetary-policy shocks takes time to build up, but eventually transmits one-to-one to long-term yields, in turn conducting the transmission of monetary policy to the wider economy.