An Examination of the Greenspan Hypothesis

This paper tests the “Greenspan Hypothesis,” which proposes a breakdown in the link between the effective federal funds rate and the mortgage interest rate between 2002 and 2005 (Greenspan 2009). We estimate and find a long run relationship between the effective federal funds rate and the conventional thirty-year mortgage interest rate using both the Engle-Granger (1987) and Johansen (1991) tests. This relationship is expressed via an error-correction representation. Tests fail to reject the null of no break in the error-correction process at any point in the 2002 to 2005 period. Subsequent testing also rejects a potential beak in the error-correction process and the effective federal funds rate parameters, nor do tests support the finding of a break in all parameters. Therefore, results fail to support the Greenspan Hypothesis as suggested by the former chairman