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Interest Rate Conundrum

  • Craine Roger

    ()

    (University of California, Berkeley)

  • Martin Vance L

    ()

    (University of Melbourne)

In June of 2004 the Fed began relentlessly tightening policy. They raised the Federal Funds Target (Target) from 1% to 5 1/4% in 1/4% increments at seventeen consecutive meetings. While short rates dutifully followed the Target up, long maturity rates actually fell. Alan Greenspan in 2005 Congressional testimony labeled the strange behavior of the spread between long rates and the Target a "conundrum." This paper examines the conundrum. We present robust empirical evidence that the increase in foreign holdings of U.S. Treasury bonds explains at least half of the decline in long maturity rates. Foreign holdings of U.S. Treasury debt with a maturity over one year grew from 20% in 1994 to 57% in 2007.

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Article provided by De Gruyter in its journal The B.E. Journal of Macroeconomics.

Volume (Year): 9 (2009)
Issue (Month): 1 (March)
Pages: 1-29

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Handle: RePEc:bpj:bejmac:v:9:y:2009:i:1:n:8
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