Further Evidence on Greenspan’s Conundrum

During his February 2005 congressional testimony, Alan Greenspan identified what he termed a conundrum. Despite the fact that the Federal Open Market Committee (FOMC) had increased the federal funds rate 150 basis points since June 2004, the 10-year Treasury yield remained essentially unchanged. Greenspan considered several explanations for his observation but rejected each. Thornton (2018) showed that the relationship between the 10-year Treasury yield and the federal funds rate changed in the late 1980s, many years prior to Greenspan's observation. Moreover, he showed that the relationship changed because the FOMC began using the federal funds rate as its policy instrument. The federal funds rate moved only when the FOMC changed its target for it, while, in contrast, the 10-year Treasury yield continued to respond to news as before. As a consequence of this change in the FOMC's operating procedure, the correlation between changes in the funds rate and the 10-year Treasury yield declined—effectively to zero. There is no obvious reason that the U.S. experience should be unique. Hence, we explore the experiences of two other countries that implemented a policy of targeting a short-term rate. We find that, as in the United States, the correlation between the policy rate and the long-term sovereign bond yield declined effectively to zero for both the Bank of England and the Reserve Bank of New Zealand after they began using a short-term rate as their policy instrument.