The Great Moderation and the Decoupling of Monetary Policy from Long-Term Rates in the U.S. and Germany

We apply the asymmetric ARDL model advanced by Shin, Yu and Greenwood-Nimmo (2009) to the analysis of the patterns of pass-through from policy-controlled interest rates to a variety of longer-term rates in the U.S. and Germany. Our results reveal three main phenomena. Firstly, while the e®ect of a rate hike is largely con¯ned to the short-run, the e®ect of a rate cut is muted in the short-run but non-negligible at longer horizons. We characterise this pattern as a switch from short-run positive asymmetry to long-run negative asymmetry, a pattern that potentially reconciles the con°icting empirical evidence and theoretical conjectures that dominate the existing literature. Secondly, our results con¯rm that there has been a decoupling of long-term rates from policy-controlled rates during the period of the Great Moderation in both the U.S. and Germany, albeit in a complex and nonlinear way. Thirdly, by replicating Taylor's (2007) counterfactual exercise using our asymmetric models, we ¯nd that Taylor over-estimates the importance of policy-controlled rates for the broader economy. Equivalently, our results do not support Greenspan's belief that the decoupling is a recent phenomenon. In light of our findings, we conclude that a narrow focus on the interest rate as the sole instrument of monetary policy is likely to be sub-optimal under current institutional arrangements.