Monetary Policy and Long-Term Real Rates
Executive Summary — Samuel G. Hanson and Jeremy C. Stein document that distant real forward rates react strongly to news about the future stance of monetary policy. These movements in forward rates appear to reflect changes in term premia, which largely accrue over the next year, as opposed to varying expectations about future real rates. The evidence suggests that one driving force behind time-varying term premia is the behavior of yield-oriented investors, who react to a cut in short rates by increasing their demand for longer-term bonds, thereby putting downward pressure on long-term rates. Key concepts include:
- The authors document the strong sensitivity of long-term real forward rates to monetary policy news, and argue that this relationship is likely to be causal.
- Movements in long-term real forward rates around monetary policy announcements appear reflect changes in term premia.
- Concretely, the authors find that a 100 basis-point (bp) increase in the 2-year nominal yield on a Federal Open Markets Committee (FOMC) announcement day is associated with a 42 bp increase in the 10-year forward overnight real rate, extracted from the yield curve for Treasury Inflation Protected Securities (TIPS).
Changes in monetary policy have surprisingly strong effects on forward real rates in the distant future. A 100 basis-point increase in the 2-year nominal yield on an FOMC announcement day is associated with a 42 basis-point increase in the 10-year forward real rate. This finding is at odds with standard macro models based on sticky nominal prices, which imply that monetary policy cannot move real rates over a horizon longer than that over which all prices in the economy can readjust. Rather, the responsiveness of long-term real rates to monetary shocks appears to reflect changes in term premia. One mechanism that may generate such variation in term premia is based on demand effects coming from "yield-oriented" investors. We find some evidence supportive of this channel.