The Excess Sensitivity of Long-Term Interest Rates: Evidence and Implications for Macroeconomic Models

44 Pages Posted: 9 Mar 2004

See all articles by Refet S. Gürkaynak

Refet S. Gürkaynak

Bilkent University - Department of Economics

Brian P. Sack

Board of Governors of the Federal Reserve - Monetary and Financial Market Analysis Section

Eric T. Swanson

University of California, Irvine - Department of Economics

Date Written: August 13, 2003

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: Long-term interest rates, excess volatility, inflation expectations

JEL Classification: G14, E52

Suggested Citation

Gürkaynak, Refet S. and Sack, Brian P. and Swanson, Eric T., The Excess Sensitivity of Long-Term Interest Rates: Evidence and Implications for Macroeconomic Models (August 13, 2003). Available at SSRN: https://ssrn.com/abstract=477481 or http://dx.doi.org/10.2139/ssrn.477481

Refet S. Gürkaynak

Bilkent University - Department of Economics ( email )

06533 Ankara
Turkey

Brian P. Sack (Contact Author)

Board of Governors of the Federal Reserve - Monetary and Financial Market Analysis Section ( email )

20th and C Streets, NW
Washington, DC 20551
United States
202-736-5671 (Phone)
202-452-2301 (Fax)

Eric T. Swanson

University of California, Irvine - Department of Economics ( email )

University of California, Irvine
3151 Social Science Plaza
Irvine, CA 92697-5100
United States
(949) 824-8305 (Phone)

HOME PAGE: http://www.ericswanson.org

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