1We would like to thank Motohiro Yogo, Angelo Melino, Hagen Kim, and seminar participants

We explore the bond-pricing implications of an exchange economy where (i) preference shocks result in time-varying term premiums in real yields, and (ii) a monetary policy Taylor rule determines inflation and nominal term premiums. A calibrated version of the model matches the observed term structure of both the mean and volatility of yields. In addition, unlike a comparable model with exogenous inflation, a Taylor rule that matches the properties of observed inflation creates nominal term premiums that remain volatile even at long maturi-ties. Experiments with different parameter values for the Taylor rule demonstrate that the nominal term premiums can be highly sensitive to monetary policy, and that the recent de-crease in the level and volatility of the nominal yields could be the result of a more aggressive monetary policy