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The Unusual Behavior of the Federal Funds Rate and Treasury Yields: A Conundrum or an Instance of Goodhart's Law?

In February 2005, Fed 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 document that the relationship between Treasury yields and the federal funds rate changed dramatically in the late 1980s, well in advance of Greenspan’s observation. I hypothesize that the marked change in the relationship is a consequence of the Federal Open Market Committee switching from using the funds rate as an operating instrument to using the funds rate to implement monetary policy, i.e., change in the relationship is an instance of Goodhart’s Law. Evidence from a variety of sources supports this hypothesis.

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