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Decoupling between the Federal Funds Rate and Long-term Interest Rates: Decreasing Effectiveness of Monetary Policy in the U.S

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  • Hasan Cömert
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    Abstract

    Cömert investigates the relationship between overnight interest rates and the long-term rates in the US from 1983q1 to 2007q3. He presents evidence supporting the argument that there was a gradual decoupling between the Fed interest rate and long-term interest rates even before the recent crisis. In other words, the Fed was gradually losing its control over long-term interest rates. As opposed to many economists’ claims, the period after 2001 was a continuation of a process which has surfaced since the end of the 1980s. Both descriptive statistics and different econometric techniques robustly support the argument that the decoupling began way earlier than 2001. Furthermore, the purchase of the US assets by foreigners might have played some role in this process although the findings related to this are not very robust.

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    File URL: http://www.peri.umass.edu/fileadmin/pdf/working_papers/working_papers_251-300/WP295.pdf
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    Bibliographic Info

    Paper provided by Political Economy Research Institute, University of Massachusetts at Amherst in its series Working Papers with number wp295.

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    Date of creation: 2012
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    Handle: RePEc:uma:periwp:wp295

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    Keywords: Central Banking; Federal Funds Rate; US Monetary Policy; Short-Term and Long Term Interest Rates; Decoupling;

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    1. Campbell, John Y & Shiller, Robert J, 1991. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 58(3), pages 495-514, May.
    2. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "The science of monetary policy: A new Keynesian perspective," Economics Working Papers 356, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 1999.
    3. De Loubens, A. & Idier, J. & Jardet, C., 2007. "Determinants of long-term interest rates in the United States and the euro area: A multivariate approach," Working papers, Banque de France 170, Banque de France.
    4. Jushan Bai & Serena Ng, 2004. "A PANIC Attack on Unit Roots and Cointegration," Econometrica, Econometric Society, Econometric Society, vol. 72(4), pages 1127-1177, 07.
    5. Arturo Estrella, 2005. "Why Does the Yield Curve Predict Output and Inflation?," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 115(505), pages 722-744, 07.
    6. Michael Woodford, 2002. "Financial market efficiency and the effectiveness of monetary policy," Economic Policy Review, Federal Reserve Bank of New York, Federal Reserve Bank of New York, issue May, pages 85-94.
    7. Friedman, Benjamin M, 2000. "Decoupling at the Margin: The Threat to Monetary Policy from the Electronic Revolution in Banking," International Finance, Wiley Blackwell, vol. 3(2), pages 261-72, July.
    8. Christopher F Baum & Mark E. Schaffer & Steven Stillman, 2007. "Enhanced routines for instrumental variables/GMM estimation and testing," Boston College Working Papers in Economics 667, Boston College Department of Economics, revised 05 Sep 2007.
    9. Arturo Estrella & Frederic S. Mishkin, 1996. "The yield curve as a predictor of U.S. recessions," Current Issues in Economics and Finance, Federal Reserve Bank of New York, Federal Reserve Bank of New York, vol. 2(Jun).
    10. David Romer, 2000. "Keynesian Macroeconomics without the LM Curve," NBER Working Papers 7461, National Bureau of Economic Research, Inc.
    11. Glenn D. Rudebusch & Eric T. Swanson & Tao Wu, 2006. "The bond yield "conundrum" from a macro-finance perspective," Working Paper Series 2006-16, Federal Reserve Bank of San Francisco.
    12. John Y. Campbell, 1995. "Some Lessons from the Yield Curve," Harvard Institute of Economic Research Working Papers 1713, Harvard - Institute of Economic Research.
    13. Benjamin M. Friedman, 2000. "Decoupling at the Margin: The Threat to Monetary Policy from the Electronic Revolution in Banking," NBER Working Papers 7955, National Bureau of Economic Research, Inc.
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