BPEA | 1984 No. 1

Do Long-Term Interest Rates Overreact to Short-Term Interest Rates?

Lawrence H. Summers and
Lawrence H. Summers Charles W. Eliot University Professor and President Emeritus - Harvard University
N. Gregory Mankiw
N. Gregory Mankiw Robert M. Beren Professor of Economics - Harvard University

1984, No. 1

THE TERM STRUCTURE of interest rates has been extensively studied by economists. It is of interest to financial economists because of its close connection with the pricing of bonds of different maturities. More important, understanding the term structure of interest rates is also critical to the evaluation of the effects of alternative macroeconomic policies. For example, it is widely believed that the monetary authority can most directly control short-term interest rates, but that aggregate demand depends primarily on long-term interest rates. If this conviction is correct, the monetary transmission mechanism relies on the behavior of the term structure of interest rates.