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The excess sensitivity of long-term interest rates: evidence and implications for macroeconomic models

Refet Gürkaynak, Brian P. Sack and Eric Swanson

No 2003-50, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: This paper demonstrates that long-term forward interest rates in the U.S. often react considerably to surprises in macroeconomic data releases and monetary policy announcements. This behavior is inconsistent with the assumption of many macroeconomic models that the long-run properties of the economy are time-invariant and perfectly known by all economic agents. Under those conditions, the shocks we consider would have only transitory effects on short-term interest rates, and hence would not generate large responses in forward rates. Our empirical findings suggest that private agents adjust their expectations of the long-run inflation rate in response to macroeconomic and monetary policy surprises. Consistent with our hypothesis, forward rates derived from inflation-indexed Treasury debt show little sensitivity to these shocks, indicating that the response of nominal forward rates is mostly driven by inflation compensation. In addition, we find that in the U.K., where the long-run inflation target is known by the private sector, long-term forward rates have not demonstrated excess sensitivity since the Bank of England achieved independence in mid-1997. We present an alternative model in which agents' perceptions of long-run inflation are not completely anchored, which fits all of our empirical results.

Keywords: Interest rates; Inflation (Finance) (search for similar items in EconPapers)
Date: 2003
New Economics Papers: this item is included in nep-mac, nep-mon and nep-rmg
References: Add references at CitEc
Citations: View citations in EconPapers (68)

Published in American Economic Review, v. 95, no. 1 (March 2005) pp. 425-436

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