The US Long-Term Interest Rate Conundrum

Abstract

US long-term interest rates evolved between 4 and 4.5% from the third quarter of 2004 to the third quarter of 2005. In the same time, the Federal Reserve raised its short-term rate. The last one was increased from 1% in June 2004 to 4.75% in March 2006. The long rate has thus been considered too low. In this essay, we will primarily try to assess the monetary policy effects on the US long-term interest rate. We will do some dynamic forecasts in order to gauge if the long rate sluggishness is in line with future short-term rate and inflation rate expectations. Indeed, simulations show that the long rate would be about 70 basis points below our forecasts. To explain this conundrum, we will explore two hypotheses that have been advocated: a Global Saving Glut and a rise in Pension Funds and Foreigners' long-term asset purchases. The latter hypothesis makes it possible to elucidate a great part of the gap between the long rate and the forecasts.