Journal of Political Economy Vol. 134 No. 2 2026
The Short-Run Policy Constraints of Long-Run Expectations
Abstract
This paper provides theory and evidence that distorted long-term interest rate expectations limit the effectiveness of monetary policy. Beliefs that depart from rational expectations break the tight link between policy rates and long-term interest rates, even when determined by the expectations hypothesis of the yield curve. Because long-term expectations are excessively sensitive to short-term interest rates, optimal policy is less aggressive relative to rational expectations. More aggressive policy leads to suboptimal volatility in long-term interest rates and aggregate demand through standard intertemporal substitution effects. These effects are quantitatively important in the United States over the postwar period.
- DOI
- 10.1086/738335
- Volume
- 134
- Issue
- 2
- Pages
- 525-569
- Language
- en
- Sources
- semanticscholar openalex crossref