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Working Paper 2007-039B

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"The Unusual Behavior of the Federal Funds and 10-Year Treasury Rates: A Conundrum or Goodhart’s Law?"
by Daniel L. Thornton

In February 2005, former Chairman Alan Greenspan referred to the decline in long-term rates in the wake of the Fed increasing the target for the federal funds rate by 150 basis points as a “conundrum.” Greenspan’s remarks generated considerable interest and research. I show that the relationship between the 10-year Treasury yield and the federal funds rate changed dramatically in the late 1980s, well in advance of Greenspan’s observation. I argue that the marked change in the relationship between the federal funds rate and the 10-year yield is a consequence of the Fed using the funds rate as a policy target rather than an operating instrument, as it did in the 1970s and early 1980s. The use of the funds rate as a policy target not only affected the relationship between the funds rate and the 10-year yield, but other rates in the term structure as well. Because of the close relationship between the funds rate and other shorter-term rates, it also affected the relationship between the 10-year yield and other shorter-term rates.

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Category > Monetary Policy/Macroeconomics
Author > Daniel L. Thornton