Real Term Structure and New Keynesian Models

Recently some authors have argued that a New Keynesian model with simple modifications can match the nominal term structure of interest rates. In this paper, I investigate how well these models do in matching the term structure of real rates using TIPS data. I find that a standard New Keynesian model that is successful in matching nominal term structure properties cannot match real yield curve features. Then I investigate the model's relative success in fitting the nominal term structure and show that the model generates implausibly volatile inflation expectations and an implausibly high inflation risk premium to fit the nominal yield curve to compensate for the lack of fit to real yields. I study various potential extensions of the benchmark model and find that incorporating labor market frictions, long-run productivity risks, and preference shocks is not helpful in matching real term structure features.