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Cracking the Conundrum

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  • David K. Backus

    (New York University)

  • Jonathan H. Wright

    (Board of Governors of the Federal Reserve System)

Abstract

From 2004 to 2006 the Federal Open Market Committee raised the target federal funds rate by 4.25 percentage points, yet long-maturity yields and forward rates fell. We consider several possible explanations for this conundrum of rising short-term and falling long-term interest rates. The most likely, in our view, is a fall in the term premium, probably associated with some combination of diminished macroeconomic and financial market volatility, more predictable monetary policy, and the state of the business cycle.

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Bibliographic Info

Article provided by Economic Studies Program, The Brookings Institution in its journal Brookings Papers on Economic Activity.

Volume (Year): 38 (2007)
Issue (Month): 1 ()
Pages: 293-329

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Handle: RePEc:bin:bpeajo:v:38:y:2007:i:2007-1:p:293-329

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Keywords: macroeconomics; Federal funds rate; interest rates; financial market volatility;

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References

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  1. Gurkaynak, Refet S. & Sack, Brian & Wright, Jonathan H., 2007. "The U.S. Treasury yield curve: 1961 to the present," Journal of Monetary Economics, Elsevier, Elsevier, vol. 54(8), pages 2291-2304, November.
  2. Refet S. G├╝rkaynak & Brian Sack & Eric Swanson, 2005. "The Sensitivity of Long-Term Interest Rates to Economic News: Evidence and Implications for Macroeconomic Models," American Economic Review, American Economic Association, American Economic Association, vol. 95(1), pages 425-436, March.
  3. Seonghoon Cho & Antonio Moreno & Geert Bekaert, 2005. "New-Keynesian Macroeconomics and the Term Structure," Faculty Working Papers, School of Economics and Business Administration, University of Navarra 04/05, School of Economics and Business Administration, University of Navarra.
  4. Andrew Ang & Monika Piazzesi, 2001. "A No-Arbitrage Vector Autoregression of Term Structure Dynamics with Macroeconomic and Latent Variables," NBER Working Papers 8363, National Bureau of Economic Research, Inc.
  5. Don H. Kim & Athanasios Orphanides, 2005. "Term structure estimation with survey data on interest rate forecasts," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2005-48, Board of Governors of the Federal Reserve System (U.S.).
  6. Randall S. Kroszner, 2006. "Why are yield curves so flat and long rates so low globally? a speech at the Bankers' Association for Finance and Trade, New York, New York, June 15, 2006," Speech, Board of Governors of the Federal Reserve System (U.S.) 219, Board of Governors of the Federal Reserve System (U.S.).
  7. Michael F. Gallmeyer & Burton Hollifield, 2005. "Taylor Rules, McCallum Rules and the Term Structure of Interest Rates," 2005 Meeting Papers, Society for Economic Dynamics 676, Society for Economic Dynamics.
  8. Ben S. Bernanke & Vincent R. Reinhart & Brian P. Sack, 2004. "Monetary policy alternatives at the zero bound: an empirical assessment," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2004-48, Board of Governors of the Federal Reserve System (U.S.).
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  12. Meredith Beechey, 2006. "A closer look at the sensitivity puzzle: the sensitivity of expected future short rates and term premia to macroeconomic news," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2007-06, Board of Governors of the Federal Reserve System (U.S.).
  13. John H. Cochrane & Monika Piazzesi, 2005. "Bond Risk Premia," American Economic Review, American Economic Association, American Economic Association, vol. 95(1), pages 138-160, March.
  14. Shiller, Robert J, 1979. "The Volatility of Long-Term Interest Rates and Expectations Models of the Term Structure," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 87(6), pages 1190-1219, December.
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