Conundrum or complication : a study of yield curve dynamics under unusual economic conditions and monetary policies

The definition of the decline of long term yields in the light of increasing short term yields as a conundrum by Chairman Greenspan in February 2005 has generated a significant amount of research. This paper presents a study of yield curve dynamics over this period using economic surprise data as the diagnostic tool. Results are presented for both US and Japanese data which indicate a non-linear response of the yield curve to economic data and monetary policy over the period in question. Further, a limited model is presented that is consistent with the observations. This can lead to an explanation of the conundrum in terms of a non-linear yield response to expected long term inflation and a variable expected long term real rate.