Working Paper: NBER ID: w1669
Authors: N. Gregory Mankiw; Jeffrey A. Miron
Abstract: We reexamine the expectations theory of the term structure using data at the short end of the maturity spectrum. We find that prior to the founding ofthe Federal Reserve System in 1915, the spread between long rates and short rates has substantial predictive power for the path of interest rates; after 1915, however, the spread contains much less predictive power. We then show that the short rate is approximately a random walk after the founding of the Fed but not before. This latter fact, coupled with even slight variation inthe term premium, can explain the observed change in 1915 in the performance of the expectations theory. We suggest that the random walk character of the short rate may be attributable to the Federal Reserve's commitment to stabilizing interest rates.
Keywords: term structure; interest rates; expectations theory; monetary policy
JEL Codes: E43; E44
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| the slope of the yield curve (E43) | the path of the short rate (E43) |
| the founding of the Federal Reserve in 1915 (N22) | the predictive power of the spread diminishes (C59) |
| the short rate behaves as a random walk (E43) | the predictability of the short rate diminishes (E43) |
| the variation in the term premium over time (E43) | the performance of the expectations theory (D84) |
| the Fed's stabilization efforts (E52) | the predictability of the short rate (E43) |