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Monetary policy and the behavior of long-term interest rates

Author

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  • Jeffrey C. Fuhrer
  • George R. Moore

Abstract

Real output is strongly correlated with the short-term nominal rate of interest. However, standard models of aggregate demand suggest that real output should be correlated with an expected long-term real rate of interest. We argue that the observed output-nominal rate correlation is an artifact of monetary policy. The systematic behavior of monetary policy, in combination with sluggish inflation adjustment and a structural IS curve that relates output to the rationally expected long-term real rate of interest, has made the sample path of the long-term real rate look like the short-term nominal rate. Thus the statistical correlation between the nominal rate and output arises in the interaction of monetary policy with the rest of the macroeconomy; it is not a structural relationship that policy is free to exploit.

Suggested Citation

  • Jeffrey C. Fuhrer & George R. Moore, 1993. "Monetary policy and the behavior of long-term interest rates," Working Papers in Applied Economic Theory 93-05, Federal Reserve Bank of San Francisco.
    • Handle: RePEc:fip:fedfap:93-05
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    Citations

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    Cited by:

    1. John B. Taylor, 1994. "The inflation/output variability trade-off revisited," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, vol. 38, pages 21-24.
    2. Bennett T. McCallum, 2005. "Monetary policy and the term structure of interest rates," Economic Quarterly, Federal Reserve Bank of Richmond, vol. 91(Fall), pages 1-21.
    3. Jeffrey C. Fuhrer & Brian F. Madigan, 1997. "Monetary Policy When Interest Rates Are Bounded At Zero," The Review of Economics and Statistics, MIT Press, vol. 79(4), pages 573-585, November.
    4. Michał Brzoza-Brzezina, 2002. "Estimating the Natural Rate of Interest: A SVAR Approach," NBP Working Papers 27, Narodowy Bank Polski.

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