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Cracking the Conundrum

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  • David K. Backus
  • Jonathan H. Wright

Abstract

From 2004 to 2006, the FOMC raised the target federal funds rate by 4.25%, yet long-maturity yields and forward rates fell. We consider several possible explanations for this "conundrum." 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.

Suggested Citation

  • David K. Backus & Jonathan H. Wright, 2007. "Cracking the Conundrum," NBER Working Papers 13419, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:13419
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    Cited by:

    1. Gil-Alana, Luis A. & Moreno, Antonio, 2012. "Uncovering the US term premium: An alternative route," Journal of Banking & Finance, Elsevier, vol. 36(4), pages 1181-1193.
    2. Don H. Kim, 2008. "Challenges in macro-finance modeling," Finance and Economics Discussion Series 2008-06, Board of Governors of the Federal Reserve System (U.S.).
    3. Jongen, Ron & Verschoor, Willem F.C. & Wolff, Christian C.P., 2011. "Time-variation in term premia: International survey-based evidence," Journal of International Money and Finance, Elsevier, vol. 30(4), pages 605-622, June.
    4. Andersen, Torben G. & Bollerslev, Tim & Christoffersen, Peter F. & Diebold, Francis X., 2013. "Financial Risk Measurement for Financial Risk Management," Handbook of the Economics of Finance, Elsevier.
    5. Modena, Matteo, 2008. "Yield curve, time varying term premia, and business cycle fluctuations," MPRA Paper 8873, University Library of Munich, Germany.
    6. repec:wsi:qjfxxx:v:04:y:2014:i:01:n:s2010139214500013 is not listed on IDEAS
    7. Taboga, Marco, 2009. "Macro-finance VARs and bond risk premia: A caveat," Review of Financial Economics, Elsevier, vol. 18(4), pages 163-171, October.
    8. Refet S. Gürkaynak & Brian Sack & Jonathan H. Wright, 2010. "The TIPS Yield Curve and Inflation Compensation," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(1), pages 70-92, January.
    9. Mariano Kulish & Daniel Rees, 2008. "Monetary Transmission and the Yield Curve in a Small Open Economy," RBA Research Discussion Papers rdp2008-03, Reserve Bank of Australia.
    10. De Graeve, Ferre & Emiris, Marina & Wouters, Raf, 2009. "A structural decomposition of the US yield curve," Journal of Monetary Economics, Elsevier, vol. 56(4), pages 545-559, May.
    11. repec:kap:rqfnac:v:49:y:2017:i:1:d:10.1007_s11156-016-0584-y is not listed on IDEAS
    12. Gregory H. Bauer & Antonio Diez de los Rios, 2012. "An International Dynamic Term Structure Model with Economic Restrictions and Unspanned Risks," Staff Working Papers 12-5, Bank of Canada.
    13. Luis Ceballos & Alberto Naudon & Damián Romero, 2016. "Nominal term structure and term premia: evidence from Chile," Applied Economics, Taylor & Francis Journals, vol. 48(29), pages 2721-2735, June.
    14. Dániel Horváth & Péter Kálmán & Zalán Kocsis & Imre Ligeti, 2014. "What factors influence the yield curve?," MNB Bulletin (discontinued), Magyar Nemzeti Bank (Central Bank of Hungary), vol. 9(1), pages 28-39, March.
    15. Oreste Tristani & Gianni Amisano, 2010. "A nonlinear DSGE model of the term structure with regime shifts," 2010 Meeting Papers 234, Society for Economic Dynamics.
    16. Matteo Modena, 2008. "The Term Structure and the Expectations Hypothesis: a Threshold Model," Working Papers 2008_36, Business School - Economics, University of Glasgow.
    17. Dewachter, Hans & Iania, Leonardo, 2012. "An Extended Macro-Finance Model with Financial Factors," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 46(06), pages 1893-1916, February.
    18. Michael D. Bauer, 2015. "Restrictions on Risk Prices in Dynamic Term Structure Models," CESifo Working Paper Series 5241, CESifo Group Munich.
    19. Bruno Feunou & Jean-Sébastien Fontaine, 2014. "Bond Risk Premia and Gaussian Term Structure Models," Staff Working Papers 14-13, Bank of Canada.
    20. Dániel Horváth & Péter Kálmán & Zalán Kocsis & Imre Ligeti, 2014. "Short-rate expectations and term premia: experiences from Hungary and other emerging market economies," BIS Papers chapters,in: Bank for International Settlements (ed.), The transmission of unconventional monetary policy to the emerging markets, volume 78, pages 185-196 Bank for International Settlements.
    21. Jardet, Caroline & Monfort, Alain & Pegoraro, Fulvio, 2013. "No-arbitrage Near-Cointegrated VAR(p) term structure models, term premia and GDP growth," Journal of Banking & Finance, Elsevier, vol. 37(2), pages 389-402.
    22. Don H Kim, 2007. "Spanned stochastic volatility in bond markets: a reexamination of the relative pricing between bonds and bond options," BIS Working Papers 239, Bank for International Settlements.
    23. Luis M. Viceira & Adi Sunderam & John Y. Campbell, 2008. "Inflation Bets or Deflation Hedges? The Changing Risks of Nominal Bonds," 2008 Meeting Papers 355, Society for Economic Dynamics.
    24. repec:eee:quaeco:v:66:y:2017:i:c:p:314-327 is not listed on IDEAS
    25. Saar, Dan & Yagil, Yossi, 2015. "Forecasting growth and stock performance using government and corporate yield curves: Evidence from the European and Asian markets," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 37(C), pages 27-41.

    More about this item

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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