Monetary policy and long-term interest rates: Evidence from the U.S. economy

This paper addresses the ability of central banks to affect the structure of interest rates. We assess the causal relationship between the short-term Effective Federal Funds Rate (FF) and long-term interest rates associated with both public and private bonds and specifically, the 10-Year Treasury Bond (GB10Y) and the Moody's Aaa Corporate Bond (AAA). To do this, we apply Structural Vector Autoregressive models to U.S. monthly data for the 1954–2018 period. Based on results derived from impulse response functions and forecast error variance decomposition, we find: a bidirectional relationship when GB10Y is considered as the long-term rate and a unidirectional relationship that moves from short- to long-term interest rates when AAA is considered. These conclusions show that monetary policy is able to permanently affect long-term interest rates and the central bank has a certain degree of freedom in setting the levels of the short-term policy rate.