Tobias Adrian, Richard K. Crump, Peter A. Diamond, and Rui Yu



In a previous post, we showed how market rates on U.S. Treasuries violate the expectations hypothesis because of time-varying risk premia. In this post, we provide evidence that term structure models have outperformed direct market-based measures in forecasting interest rates. This suggests that term structure models can play a role in long-run planning for public policy objectives such as assessing the viability of Social Security.

A Conversation with Ken Garbade



Few people know the Treasury market from as many angles as Ken Garbade, a senior vice president in the Money and Payments Studies area of the New York Fed’s Research Group. Ken taught financial markets at NYU’s graduate school of business for many years before heading to Wall Street to assume a position in the research department of the primary dealer division of Bankers Trust Company. At Bankers, Ken conducted relative-value research on the Treasury market, assessing how return varies relative to risk for particular Treasury securities. For a time, he also traded single-payment Treasury obligations known as STRIPS—although not especially successfully, he notes.

Thomas Klitgaard and Harry Wheeler



Japan’s general government debt-to-GDP ratio is the highest of advanced economies, due in part to increased spending on social services for an aging population and a level of nominal GDP that has not increased for two decades. The interest rate payments from taxpayers on this debt are moderated by income earned on government assets and by low interest rates. One might think that the Bank of Japan’s purchases of government bonds would further ease the burden on taxpayers, with interest payments to the Bank of Japan on its bond holdings rebated back to the government. Merging the balance sheets of the government and the Bank, however, shows that the asset purchase program alters the composition of public debt, with reserves in the banking system replacing government bonds, but not the amount of the debt taxpayers must pay interest on.

By Hunter L. Clark, Andrew F. Haughwout, and James A. Orr




Puerto Rico’s economic and fiscal challenges have been an important focus of work done here at the New York Fed, resulting in two reports (2012 and 2014), several blog posts and one paper in our Current Issues series in just the last few years. As the Commonwealth’s problems have deepened, the Obama administration and Congress have begun discussing potential approaches to addressing them. In this post, we update our previous estimates of Puerto Rico’s outstanding debt and discuss the effect that various forms of bankruptcy protection might have on the Commonwealth.

Tobias Adrian, Richard K. Crump, Peter A. Diamond, and Rui Yu



Expectations about the path of interest rates matter for many economic decisions. Three sources for obtaining information about such expectations are available. The first is extrapolation from historical data. The second consists of surveys of expectations. The third are expectations drawn from financial market prices, often referred to as market expectations. The last are usually considered to be model-based expectations, because, generally, a model is needed to reliably extract expectations from current prices. In this post, we explain the need for and usage of term structure models for extracting far in the future interest rate expectations from market rates, which can be used to discount the long run. We will illustrate our arguments by discussing the measurement of long-run discount rates for Social Security.

Anna Snider

Each year, the manager of the Federal Reserve’s System Open Market Account (SOMA) submits an accounting of open market operations and other developments influencing the composition and performance of the Fed’s balance sheet to the Federal Open Market Committee (FOMC).

Andrew Haughwout



On Tuesday, April 14, the Federal Reserve Bank of New York hosted an all-day workshop entitled Chapter 9 and Alternatives for Distressed Municipalities and States. The workshop was jointly organized and sponsored by the Volcker Alliance and George Mason University’s State and Local Government Leadership Center. The event brought together key experts, practitioners, and researchers on the subject of fiscal distress at the state and local level. The aim of the session was to foster discussion on the role of Chapter 9 of the U.S. Bankruptcy Code, alternatives for distressed governments, and strategies to avoid stress and achieve good fiscal outcomes.

Marco Del Negro and Christopher A. Sims

The monetary base in the United States, defined as currency plus bank reserves, grew from about $800 billion in 2008 to $2 trillion in 2012, and to roughly $4 trillion at the end of 2014 (see chart below). Some commentators have viewed this increase in the monetary base as a sure harbinger of inflation. For example, one economist wrote that this “unprecedented expansion of the money supply could make the '70s look benign.” These predictions of inflation rest on the monetarist argument that nominal income is proportional to the money supply. The fact that the money supply has expanded rapidly while real income has grown very modestly means that sooner or later prices will have to catch up. Most academic economists (from Cochrane to Krugman and Mankiw) disagree. The monetarist argument arguably applies only to non-interest-bearing central bank liabilities, but since October 2008 a large fraction of the monetary base has consisted of reserves that pay interest (the so-called IOER, or interest on excess reserves) and one linchpin of the Fed’s “policy normalization principles” consists precisely in raising the IOER along with the federal funds rate. Since reserves pay close to market interest rates, they are close substitutes for other short-term assets such as Treasury bills from a bank’s perspective. As long as the central bank can affect the return on these short-term assets by adjusting the IOER, controlling inflation with a large balance sheet seems no different than it was before the Great Recession.

Marco Del Negro, Marc Giannoni, Raiden B. Hasegawa, and Frank Schorfheide

GDP contracted 4 percent from 2008:Q2 to 2009:Q2, and the unemployment rate peaked at 10 percent in October 2010. Traditional backward-looking Phillips curve models of inflation, which relate inflation to measures of “slack” in activity and past measures of inflation, would have predicted a substantial drop in inflation. However, core inflation declined by only one percentage point, from 2.2 percent in 2007 to 1.2 percent in 2009, giving rise to the “missing deflation” puzzle. Based on this evidence, some authors have argued that slack must have been smaller than suggested by indicators such as the unemployment rate or deviations of GDP from its long-run trend. On the contrary, in Monday’s post, we showed that a New Keynesian DSGE model can explain the behavior of inflation in the aftermath of the Great Recession, despite large and persistent output gaps. An implication of this model is that information about the future stance of monetary policy is very important in determining current inflation, in contrast to backward-looking Phillips curve models where all that matters is the current and past stance of policy.

Rajashri Chakrabarti and Matthew Mazewski

Even the most casual observer of American politics knows that today’s Republican and Democratic parties seem to disagree with one another on just about every issue under the sun. Some assume that this divide is merely an inevitable feature of a two-party system, while others reminisce about a golden era of bipartisan cooperation and hold out hope that a spirit of compromise might one day return to Washington. In this post, we present evidence that political polarization—or the trend toward more ideologically distinct and internally homogeneous parties—is not a recent development in the United States, although it has reached unprecedented levels in the last several years. We also show that polarization is strongly correlated with the extent of income inequality, but only weakly associated with the rate of economic growth. We offer several tentative explanations for these relationships, and discuss whether all forms of polarization are created equal.