Cracking the Conundrum
From 2004 to 2006, the FOMC raised the target federal funds rate by 4.25%, yet long-maturity yields and forward rates fell. We consider several possible explanations for this "conundrum." The most likely, in our view, is a fall in the term premium, probably associated with some combination of diminished macroeconomic and financial market volatility, more predictable monetary policy, and the state of the business cycle.
Prepared for the March 2007 meeting of the Brookings Panel on Economic Activity. The paper was written while Wright was on leave at the University of Pennsylvania. It began as two separate discussions of John Cochrane and Monika Piazzesi's "Decomposing the yield curve." We thank them for their insights. We also thank Bill Brainard, Frank Diebold, Don Kim, George Perry, Dick Sylla, and Stan Zin for comments and advice. The views expressed are the sole responsibility of the authors and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System, any other employees of the Federal Reserve System, or the National Bureau of Economic Research.
David K. Backus & Jonathan H. Wright, 2007. "Cracking the Conundrum," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 38(2007-1), pages 293-329. citation courtesy of