The Sensitivity of Long-Term Interest Rates to Economic News: Evidence and Implications for Macroeconomic Models

This 2005 American Economic Review paper by Refet Gürkaynak, Brian Sack, and Eric Swanson asks whether long-term forward interest rates respond to daily macroeconomic and monetary-policy news, a question motivated by the fact that standard New Keynesian models – both the purely forward-looking Clarida-Gali-Gertler (2000) specification and the more persistent, partially backward-looking Rudebusch (2001) model – imply that the short-term interest rate returns to its steady state within roughly a decade after any shock, so far-ahead forward rates should show virtually no response to current news. Using daily U.S. Treasury forward rates (built from the Federal Reserve Board’s Svensson-method zero-coupon yield curve, off-the-run notes and bonds) over January 1990-December 2002, the authors regress the daily change in the forward rate at a given horizon on the surprise components of 13 macroeconomic data releases (the released value minus the median Money Market Services survey forecast, standardized by its historical standard deviation) and a federal-funds-futures-based measure of the monetary policy surprise, estimating the regression separately by OLS with Huber-White standard errors for horizons out to 15 years ahead. They find that far-ahead forward rates do respond significantly: for the forward rate ending five years ahead, 11 of the 13 macro surprises are significant at the 10-percent level (e.g., a one-standard-deviation surprise in non-farm payrolls moves the five-year-ahead forward rate by 3.48 basis points, GDP advance by 4.12 bp, the employment cost index by 4.42 bp), and 10 of 13 remain significant at the ten-year-ahead horizon, with the persistence of these effects out to 15 years described by the authors as “remarkable.” Monetary policy surprises behave differently across horizons: a surprise tightening raises near-term forward rates, consistent with the persistence of the federal funds rate, but forward rates roughly 9-15 years ahead move significantly in the opposite direction from the policy surprise – a pattern the paper contrasts with Cook and Hahn (1989) and Romer and Romer (2000), who study long-term yields (which mix in near-term rate expectations) rather than far-ahead forward rates, and attributes the discrepancy partly to their less precise policy-surprise measures. To explain this evidence that “the long-run expectations of economic agents are not strongly anchored,” the authors extend a standard asset-pricing/Fisher-equation framework by letting private agents’ estimate of the Federal Reserve’s unobserved long-run inflation target evolve over time, updated via a Kalman-filter-type rule in response to incoming data; they show that with small updating parameters (theta = 0.02 on trailing inflation, kappa = 0.1 on the monetary policy surprise) this single modification reproduces the full pattern of forward-rate responses observed in the data. They note corroborating survey evidence that the Survey of Professional Forecasters’ median ten-year CPI inflation forecast fell from about 4 percent in 1991Q4 to a little under 2.5 percent by the end of 2002, a roughly 1.5-percentage-point decline that “matches closely” the decline seen in the long-term forward-rate data. The authors are explicit that they cannot fully separate this inflation-target channel from a changing inflation/term risk premium, and that their approximation for the inflation-target process is valid only while inflation remains within the relatively low range observed over the sample; the 1990-2002 sample also predates the zero lower bound, unconventional monetary policy, and later tightening cycles.

Eric Swanson | Macro Paper Warehouse

The Sensitivity of Long-Term Interest Rates to Economic News: Evidence and Implications for Macroeconomic Models