The elimination of the 30 -year treasury bond Kirt Brookson Money & Banking ECO 6226
Project Goals To manifest the relationship between the 10 -year notes and Economic variables such as UE & inflation. l To measure how a the demise in 30 -year bonds affected all other bonds such as AAA corp. , short -term, mortgage rates l To form an opinion about the economic policy decision of the Treasury Dept. about the elimination of the 30 -year bond. (Was this the right policy for the Economy? ) l
History/Background The auction of 30 -year bonds begin on Feb 18 th, 1977 l In 1977, James Carter was the President, Inflation was approximately 11% and the economy was in a recession. l In the late 1990’s during the Clinton adminstration the Treasury started to issue less amount of 30 year bonds. l
Why? l The reason for this reduction was because of increase Fed. Surplus and Fed. Buy Bond back program and also the Fed forcasting dept. calculated a surplus up until 2008. l This decrease in liquidity, decreased the demand for the 30 -year. A year later, the yield on the 10 -Note surpassed the 30 -year On Oct 31, 2001 a month after 9/11 the Treasury announced the cancellation of this bond. Why? l 1. )The obtain the lowest borrowing rate possible to meet the FED needs. 2. )Evolution and adaptation of customer needs similar to Financial Instituitions. To give the taxpayer the lowest borrowing cost as possible. l
Reaction…. . l Investors reacted to the news drive the price of a face value $1000 denom. by $52. 81 and yields dropped to 4. 88% - from 5. 22% l On the final day of trading for the 30 -year bond(02/19/02), Treasury announced a L. T. A. Nominal yield which may be used to track the yield of 30 -year with a the aid of an extrapolation factor. l Replace by the 10 -year Note as the new bond benchmark.
Literature reviews Some Lessons from the Yield Curve Campbell. (1995) Basically, supported the argument that short-term bonds are better suited than long-term bonds for Gov. borrowing. Low rates will drive and increase Investment into the ECN which will stimulate growth. l Consequences of debt policy in a stochastically growing monetary economy. Grinols & Turnovsky (1998) In contrary, they constructed a model to refute this claim made by Campbell. Gov. should be able to issue any mixture of debt instrument maturities, just not short-term bonds. l
Continued. . . (Expectation Theoory) l Testing the expectation theory of the term structure of interest rates in the threshold model (Clements & Beatriz 2003) From this model it was determined that long-term yield may be used to determine shirt term yields only when the spread between the two are huge. l Testing the Expectations Theory of the Term Structure of Interest Rates Using Model. Selection Methods (Chao 98) This article rejected the claim by C & B , that the yield curve acts under the expectation theory.
Analysis l 2 Correlation Coeff. Each economic variable such as inflation & UE compared to the 10 -year Note (New Benchmark) after the demise of the 30 -year bond Correlation Matrix Table Correlation between all the Treasury bonds short & long, corp. and mortgage rates between Oct 1999 - Present. l
Results( Regression) l GDP- showed a positive/negative relationship and signifcant l Inflation- showed a relationship with 10 year notes l Unemployment- showed a relationship with 10 -year notes
Continued (correlation) l The relationship b/w 10 -year yields and UE is negative and weak correlation. Value=-0. 41 l The relationship b/w 10 -year yields and inflation also negative and strong correlation. Value = -0. 60
Matrix Table
Conclusion l From the analysis, it was shown that the elimination of the 30 -year bonds cause the U. S. yield curve to decrease. Which in turn is good for the ECN because individuals will have to pay less taxes. Also this downward shift caused corporate and mortgage rates to decrease. With reduced rates corp. borrowing cost will be less and encourage investment. Also individual cost will be lower which mean they’ll be able to consumer more. So, in the short it does appear that the Treasury acted correctly.
Reference l l l l Mishkin, F. , The economics of money, banking and financial markets, Addison Wesley publication, USA 2002, 6 th Edition, Campbell, J. Y. , Some Lessons from the Yield Curve, Journal of Economic Perspectives 9 (1995), 129 -152. http: //www. federalreserve. gov/releases/h 15/data. htm http: //research. stlouisfed. org/fred 2/series/AFDEF/ http: //money. cnn. com/2001/10/31/markets/longbond/ Gibbs, L. , Desperately seeking income, Money, Aug 2003, Vol. 32, Issue 8 Still in gear? Economist, 8/9/2003, Vol. 368 Issue 8336, p 57
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