Fed’s Stein Says Rate Cuts Have ‘Surprising’ Long-Term Impact

Federal Reserve Governor Jeremy Stein said shifts in U.S. central bank policy have an ability to move long-term, inflation-adjusted interest rates by a greater degree than academic theory would predict.

“Changes in the stance of monetary policy have a surprisingly strong impact on distant forward real interest rates,” Stein said in a working paper co-authored with Harvard University professor Samuel Hanson and released by the Fed today in Washington. The paper didn’t discuss the outlook for current monetary policy or the economy.

The working paper contains Stein’s first comments on monetary policy since he joined the Fed’s Board of Governors in May. Stein, 51, a Harvard University professor, brings to the central bank an academic expertise in monetary policy and financial markets.

Stein and Hanson said in the paper that their findings are surprising because standard macroeconomic models suggest that changes in Fed policy should have no effect on inflation-adjusted interest rates over a long horizon.

“It seems implausible to think that this horizon could be anything close to 10 years” according to the standard economic model used by the Fed, known as New Keynesian, the authors said.

One example of the effect, according to the paper, occurred when Fed policy makers at their January meeting pledged to hold interest rates near zero through at least late 2014. Inflation-adjusted 10-year and 20-year interest rates declined by 0.05 percentage points and 0.09 percentage points on the announcement.

The authors said the effect may be explained by the behavior of bond investors seeking higher-yielding assets when short-term interest rates fall. Future research on the topic may help to better explain the Fed’s ability to boost the real economy, they said.

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