Central Banks and Financial Markets
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Central Banks and Financial Markets

The Declining Power of US Monetary Policy

Hasan Cömert

In the wake of the financial crisis of 2008, there has been increasing debate over the appropriate role of central banks in mitigating economic disaster. This timely volume combines detailed historical and econometric analyses to explore the profound changes that occurred within the US financial system from the 1980s to the present, and shows how these changes have affected the US economy.
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Chapter 4: Weakening relationship between the federal funds rate and long-term interest rates: decreasing effectiveness of monetary policy in the US

The Declining Power of US Monetary Policy

Hasan Cömert


This chapter investigates the relationship between overnight interest rates and the long-term rates in the US from 1983q1 to 2007q3. It presents evidence supporting the argument that there has been a gradual decoupling between the Fed interest rate and long-term interest rates. In other words, the Fed has been gradually losing its control over long-term interest rates. As opposed to many economists’ claims, the period after 2001 is a continuation of a process which has surfaced since the end of the 1980s (or beginning of the 1990s). Both descriptive statistics and different econometric techniques robustly support the argument that the decoupling began way earlier than 2001. Furthermore, the purchase of US assets by foreigners might have played some role in this process although the findings related to this are not very robust. Two main implications of this chapter are that i) using overnight interest rates may not be sufficient to direct developments in an economy (especially in a situation in which other channels of the transmission mechanism deteriorates too), and ii) models based on the idea that central banks may exert great influence on economies by affecting long-term interest rates should be reconsidered.

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