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Class Year

2006

Abstract

From 2001 to 2006, U.S. long-term interest rates have remained steady while the federal funds rate has both declined and increased, as Figure 1 shows. Historically, long term interest rates tend to respond to changes in short term rates, but recently this does not appear to be the case. Former chairman of the Federal Reserve, Alan Greenspan, recently dubbed this occurrence a “conundrum,” because no one can provide a distinct explanation concerning this phenomenon. There are several noteworthy incentives for why long-term yields should have increased from 2004 to 2006, but they have remained constant during this time period. According to current economic theory, the U.S. budget deficit, the Federal Open Market Committee’s (FOMC) recent increases in short term rates, the latest recovery from recession, and the hefty current account deficit should all be contributing to higher long-term rates. Despite these macroeconomic influences, rates have not responded. Therefore, a supplementary force(s) must be creating a substantial impact. For example, this trend may be explained by a decrease in interest rate volatility, the Federal Reserve’s ability to maintain low inflation expectations, or an increase in foreign demand for U.S Treasuries. Is the ten-year Treasury yield truly a conundrum, or have macroeconomic influences caused long-term interest rates to maintain at an appropriate level? [excerpt]

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