Longer-Term Perspectives on the Yield Curve and Monetary Policy

Sharon Kozicki · Gordon H. Sellon

15 citations0/0 files storedRePEc: Research Papers in Economics

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Monetary Policy and Economic Impact Financial Markets and Investment Strategies Market Dynamics and Volatility

Abstract

In the spring of 2004, there was widespread expectation in financial markets that the Federal Reserve would shortly begin the process of raising its federal funds rate target back toward a more normal level. At the time, there was considerable concern that removing policy accommodation could lead to a sharp rise in long-term interest rates that might roil financial markets or slow the economic recovery. Much of this concern was based on the sizable increases in long-term rates that occurred when the Federal Reserve tightened policy in 1994-95 and 1999-2000. In contrast to the conventional wisdom, however, longer-term rates actually declined as the funds rate target rose. Indeed, in August 2005, after the Federal Reserve had raised its federal funds rate target from 1 percent to 3 percent, the yield on the benchmark 10-year Treasury note remained below its level at the onset of policy tightening. This surprising behavior of long-term rates has been labeled a ?conundrum? by Federal Reserve Chairman Greenspan and many financial market participants, and considerable effort has been made to understand the causes of the conundrum and its implications for monetary policy. Kozicki and Sellon provide a framework for understanding the relationship between monetary policy and the yield curve that can be used to analyze the behavior of long-term rates during periods of monetary policy tightening. The authors use the framework to examine two recent episodes of policy tightening, in 1999-2000 and 2004-05. The analysis reveals that the conundrum period is highly unusual, but it also suggests that the relationship between monetary policy and the yield curve is quite complex and highly variable over time.

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2005The Sensitivity of Long-Term Interest Rates to Economic News: Evidence and Implications for Macroeconomic Models 2002Expectation puzzles, time-varying risk premia, and affine models of the term structure 2005An Arbitrage-Free Three-Factor Term Structure Model and the Recent Behavior of Long-Term Yields and Distant-Horizon Forward Rates 2009International capital flows and U.S. interest rates 2002The Opportunistic Approach to Disinflation 2003Permanent and Transitory Policy Shocks in an Empirical Macro Model with Asymmetric Information 2005Changing beliefs and the term structure of interest rates: Cross-equation restrictions with drifting parameters 2001Can TIPS Help Identify Long-Term Inflation Expectations?

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