MONETARY-POLICY AND THE BEHAVIOR OF LONG-TERM REAL INTEREST-RATES

A time-honored description of the ''monetary transmission channel'' su ggests that the Fed controls the federal funds rate, which affects the rates on longer-term credit market instruments, which affect the expe cted real (inflation-adjusted) rates on longer-term instruments, which affect real spending on interest-sensitive goods, which affects unemp loyment and inflation. And yet one key Link in the chain, the expected real long-term interest rate, is not observable. This article explore s the Link between the behavior of monetary policy and inferences abou t the behavior of the expected long-term real rate of interest. Analys is of this Link reveals a sound empirical basis for the standard trans mission channel. It also provides an explanation of the Bernanke-Blind er observation that short-term nominal rates are highly correlated wit h real output, an explanation that is fully consistent with the standa rd transmission channel.