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The Interest Rate Conundrum

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  • Craine, Roger
  • Martin, Vance L.

Abstract

In June of 2004 the Fed began relentlessly tightening policy. They raised the Federal Funds Target (Target) from 1% to 5 1/4% in 1/4% increments at seventeen consecutive meetings. While short rates dutifully followed the Target up, long maturity rates actually fell. Alan Greenspan in 2005 Congressional testimony labeled the strange behavior of the spread between long rates and the Target a "conundrum". This paper examines the conundrum. We present robust empirical evidence that the increase in foreign holdings of US Treasury bonds explains more than half of the decline in long maturity rates. Foreign holdings of US Treasury debt with a maturity over one year grew from 20% in 1994 to 57% in 2007.

Suggested Citation

  • Craine, Roger & Martin, Vance L., 2009. "The Interest Rate Conundrum," Department of Economics, Working Paper Series qt8b98n6vh, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
    • Handle: RePEc:cdl:econwp:qt8b98n6vh
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    Cited by:

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    2. Barry Eichengreen, 2012. "Macroeconomic and Financial Policies Before and After the Crisis," Chapters, in: Maurice Obstfeld & Dongchul Cho & Andrew Mason (ed.), Global Economic Crisis, chapter 8, Edward Elgar Publishing.
    3. Eduardo Fernandez-Arias & Peter Montiel, 2009. "Crisis Response in Latin America: Is the "Rainy Day" at Hand?," Research Department Publications 4628, Inter-American Development Bank, Research Department.
    4. Thomas Goda & Photis Lysandrou, 2014. "The contribution of wealth concentration to the subprime crisis: a quantitative estimation," Cambridge Journal of Economics, Cambridge Political Economy Society, vol. 38(2), pages 301-327.
    5. Barry Eichengreen, 2010. "Globalization and the Crisis by Barry Eichengreen," CESifo Forum, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 11(3), pages 20-24, October.
    6. Byrne, Joseph P. & Fazio, Giorgio & Fiess, Norbert, 2012. "Interest rate co-movements, global factors and the long end of the term spread," Journal of Banking & Finance, Elsevier, vol. 36(1), pages 183-192.
    7. Goda, Thomas & Lysandrou, Photis & Stewart, Chris, 2013. "The contribution of US bond demand to the US bond yield conundrum of 2004–2007: An empirical investigation," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 27(C), pages 113-136.
    8. Refet S. Gürkaynak & Jonathan H. Wright, 2012. "Macroeconomics and the Term Structure," Journal of Economic Literature, American Economic Association, vol. 50(2), pages 331-367, June.
    9. Barry Eichengreen, 2010. "Globalization and the Crisis by Barry Eichengreen," CESifo Forum, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 11(03), pages 20-24, October.
    10. Pablo Moreno, 2013. "The Metamorphosis of the IMF (2009-2011)," Estudios Económicos, Banco de España, number 78.
    11. Sonali Jain-Chandra & D. Filiz Unsal, 2014. "The effectiveness of monetary policy transmission under capital inflows: Evidence from Asia," Borsa Istanbul Review, Research and Business Development Department, Borsa Istanbul, vol. 14(2), pages 96-103, June.
    12. Kučera, Adam, 2020. "Identification of triggers of U.S. yield curve movements," The North American Journal of Economics and Finance, Elsevier, vol. 54(C).
    13. 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.
    14. Arvind Subramanian, 2011. "Renminbi Rules: The Conditional Imminence of the Reserve Currency Transition," Working Paper Series WP11-14, Peterson Institute for International Economics.

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