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Measuring the Effect of the Zero Lower Bound on Medium- and Longer-Term Interest Rates

  • John Williams

    (Federal Reserve Bank of San Francisco)

  • Eric Swanson

    (Federal Reserve Bank of San Francisco)

The zero lower bound on nominal interest rates has constrained the Federal Reserve's setting of the overnight federal funds rate for over three years running. According to many macroeconomic models, such an extended period of being stuck at the zero bound has important implications for the effectiveness of monetary and fiscal policies. However, economic theory also implies that households' and firms' decisions depend on the entire path of expected future short-term interest rates, not just the current level of the overnight rate. Thus, interest rates with a year or more to maturity are arguably the most relevant for the private sector, and it is unclear to what extent the zero lower bound has affected those rates. In this paper, we propose a novel approach to measure when and to what extent the zero lower bound affects interest rates of any maturity. We compare the sensitivity of interest rates of various maturities to macroeconomic news during periods when short-term interest rates are very low to that during normal times. We find that yields on Treasury securities with six months or less to maturity have been strongly affected by the zero bound during most or all of the period when the federal funds rate was near zero. In stark contrast to this finding, yields with more than two years to maturity have responded to economic news during the past three years in their usual way. One- and two-year Treasury yields represent an intermediate case, being partially constrained by the zero bound over part of the period when the funds rate was near zero. We provide two explanations for these results. First, market participants have consistently expected the zero bound to constrain policy for only about a year into the future, minimizing its effect on longer-term yields. Second, the Federal Reserve's unconventional policy actions may be offsetting the effects of the zero bound on longer-term yields.

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Paper provided by Society for Economic Dynamics in its series 2012 Meeting Papers with number 462.

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Date of creation: 2012
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Handle: RePEc:red:sed012:462
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  1. Eric T. Swanson, 2011. "Let’s twist again: a high-frequency event-study analysis of operation twist and its implications for QE2," Working Paper Series 2011-08, Federal Reserve Bank of San Francisco.
  2. Andrea Tambalotti & Ernst Schaumburg, 2004. "An Investigation of the Gains from Commitment in Monetary Policy," Econometric Society 2004 North American Summer Meetings 282, Econometric Society.
  3. Vayanos, Dimitri & Vila, Jean-Luc, 2009. "A Preferred-Habitat Model of the Term Structure of Interest Rates," CEPR Discussion Papers 7547, C.E.P.R. Discussion Papers.
  4. James D. Hamilton & Jing Cynthia Wu, 2012. "The Effectiveness of Alternative Monetary Policy Tools in a Zero Lower Bound Environment," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44, pages 3-46, 02.
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  7. Davide Debortoli & Ricardo Nunes, 2007. "Loose commitment," International Finance Discussion Papers 916, Board of Governors of the Federal Reserve System (U.S.).
  8. Gurkaynak, Refet S. & Sack, Brian T. & Swanson, Eric P., 2007. "Market-Based Measures of Monetary Policy Expectations," Journal of Business & Economic Statistics, American Statistical Association, vol. 25, pages 201-212, April.
  9. Swanson, Eric T., 2006. "Have Increases in Federal Reserve Transparency Improved Private Sector Interest Rate Forecasts?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(3), pages 791-819, April.
  10. Viatcheslav Gorovoi & Vadim Linetsky, 2004. "Black's Model of Interest Rates as Options, Eigenfunction Expansions and Japanese Interest Rates," Mathematical Finance, Wiley Blackwell, vol. 14(1), pages 49-78.
  11. Chan, K C, et al, 1992. " An Empirical Comparison of Alternative Models of the Short-Term Interest Rate," Journal of Finance, American Finance Association, vol. 47(3), pages 1209-27, July.
  12. Arvind Krishnamurthy & Annette Vissing-Jorgensen, 2007. "The Demand for Treasury Debt," NBER Working Papers 12881, National Bureau of Economic Research, Inc.
  13. Kim, Don H. & Singleton, Kenneth J., 2012. "Term structure models and the zero bound: An empirical investigation of Japanese yields," Journal of Econometrics, Elsevier, vol. 170(1), pages 32-49.
  14. Refet S Gürkaynak & Andrew Levin & Eric Swanson, 2010. "Does Inflation Targeting Anchor Long-Run Inflation Expectations? Evidence from the U.S., UK, and Sweden," Journal of the European Economic Association, MIT Press, vol. 8(6), pages 1208-1242, December.
  15. Refet S. Gürkaynak & Brian Sack & Eric Swanson, 2005. "The Sensitivity of Long-Term Interest Rates to Economic News: Evidence and Implications for Macroeconomic Models," American Economic Review, American Economic Association, vol. 95(1), pages 425-436, March.
  16. Jonathan H. Wright, 2012. "What does Monetary Policy do to Long‐term Interest Rates at the Zero Lower Bound?," Economic Journal, Royal Economic Society, vol. 122(564), pages F447-F466, November.
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