The expectations hypothesis of the term structure when interest rates are close to zero

In an economy where cash can be stored costlessly in nominal terms, the nominal interest rate is bounded below by zero. This paper derives the implications of this non-negativity constraint for the term structure and shows that it induces a nonlinear and convex relation between short- and long-term interest rates. The long-term rate responds asymmetrically to changes in the short-term rate, and by less than that is predicted by the benchmark linear model. In particular, a decrease in the short-term rate produces a smaller response in the long-term rate than an increase of the same magnitude. The empirical predictions of the model are examined using data from Japan.