The Contribution of Foreign Holdings of U.S. Treasury Securities to the U.S. Long-Term Interest Rate: An Empirical Investigation of the Impact of the Zero Lower Bound

Enrique Martínez García () and Yixiang Zhang ()

No 430, Globalization Institute Working Papers from Federal Reserve Bank of Dallas

Abstract: We find empirical evidence of a possible structural break in the relationship between the foreign holdings of U.S. Treasury securities and the U.S. long-term interest rate occurring at the time when U.S. monetary policy became constrained at the zero-lower bound (ZLB). The estimated marginal effect of the foreign holdings ratio on the U.S. long-term interest rate, particularly its long-run effect, appears to have become stronger during the ZLB regime than it was before. We argue that the leading explanation of this apparent break is the nonlinearity introduced by the ZLB. Motivated by theory, we propose a flexible nonlinear specification to deal with the ZLB—a threshold single-equation error-correction model splitting the sample in two regimes, pre-ZLB and ZLB, which replaces the observed Fed Funds rate with a shadow Fed Funds rate derived from a Tobit-IV model to incorporate a broader measure of the stance of monetary policy. With this setup, we find no significant structural break in the relationship between foreign holdings and long-term rates at the ZLB. Therefore, we argue that the ZLB is a leading cause of the apparent shift in the empirical relationship. We also show that the estimated effects are not just statistically significant, but also economically significant. Through counterfactual analysis, we show that changes in China’s holdings of U.S. Treasury securities played an important role in explaining the 2004-2006 interest rate conundrum period and kept the long-term interest rate from going even lower in the recent ZLB period.

Keywords: long-term interest rates; foreign holdings; expectations hypothesis; structural breaks; zero lower bound (search for similar items in EconPapers)
JEL-codes: C24 E43 E58 F21 (search for similar items in EconPapers)
Pages: 49
Date: 2024-09-25
New Economics Papers: this item is included in nep-ban, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://www.dallasfed.org/~/media/documents/resear ... papers/2024/0430.pdf Full text (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:fip:feddgw:98916

DOI: 10.24149/gwp430

Access Statistics for this paper

More papers in Globalization Institute Working Papers from Federal Reserve Bank of Dallas Contact information at EDIRC.
Bibliographic data for series maintained by Amy Chapman ().