The relation of central bank credit to the broader public safety net has implications that are sometimes overlooked. For example, the collateralization of central bank credit extension may reduce risks to the central bank, but it can increase risk to the deposit insurance fund. Therefore, the central bank ought to consider more than just its own balance sheet risk in making lending decisions. This is especially important because, as the lender of last resort, the central bank can often force an institution’s closure by refusing credit.

Currently, bond yields in Europe, the United States, and Canada are quite similar and are at low levels not seen in decades. Globalization may have played a role in this convergence, though the channel is not clear. I suspect that the convergence of inflation rates and inflation expectations to common low levels is an important factor.

The conundrum was the Chairman's conundrum.

It is difficult to explain what has happened to [long-term interest] rates.  I think the credibility of monetary policy is an aspect.

A number of factors have contributed to the unusually low long-term interest rates that we have seen, but one of them has been the changing attitude of savers toward risk...As people have become increasingly confident that good economic performance will last for a while, they have asked for less extra compensation for taking the risks of lending for longer periods and to borrowers whose odds on default are usually viewed as high. These changing attitudes have helped produce an unusual phenomenon--the failure of longer-term interest rates to move higher in an expanding economy with rising short-term interest rates; for many businesses, longer-term borrowing costs have actually fallen since last summer.

Well, it's less of a conundrum now than when Chairman Greenspan made that statement.  But I think there still is a puzzle as to why long-term interest rates have been as low as they have been during this period.

The FOMC controls very short-term interest rates fairly directly. However...the Committee's control over longer-term yields and over the prices of long-lived financial assets depends crucially on its ability to influence market expectations about the likely future course of policy.

The Fed has only very indirect control over long-term yields and asset prices...To affect long-term rates, the FOMC must somehow signal to the financial markets its plans for setting future short-term rates. The most direct method is through talk...FOMC talk probably has the greatest influence on expectations of short-term rates a year or so into the future, as beyond that point the FOMC has very little, if any, advantage over market participants in forecasting the economy or even its own policy actions.

While many banks are understandably positioning their balance sheets for rising rates—by shortening asset durations, for example—some are not considering alternative scenarios with respect to the shape of the yield curve and the timing of rate changes, and we’ve already seen how the bond market and long rates have fluctuated in reaction to...economic uncertainties.

I will argue that over the past decade a combination of diverse forces has created a significant increase in the global supply of saving--a global saving glut--which helps to explain both the increase in the U.S. current account deficit and the relatively low level of long-term real interest rates in the world today...The global saving glut has been a remarkable reversal in the flows of credit to developing and emerging-market economies, a shift that has transformed those economies from borrowers on international capital markets to large net lenders.

The best single explanation that I personally have is that expectations of inflation have remained very well anchored.  So that's why in my judgment long term rates have held as low as they have for as long as they have...And if I'm right, or am at least aprtially correct, that's a gratifying result not only because it siggests a fair amount of credibility in Federal Reserve monetary policy, but a fair amount of redibility in a low inflation outlook, which is at least as important.

My guesstimate is that long rates haven't moved because inflation expectaions are so well anchored.

At some point, if financial markets expect large deficits to continue, they will very likely build into long-term interest rates a larger inflation premium. We haven't seen that yet...[But] if left undealt with, large and continuing and growing deficits will lead to higher long-term interest rates, and that's certainly not in the interest of the economy.

It is difficult to attribute the long-term interest rate declines of the last nine months to glacially increasing globalization. For the moment, the broadly unanticipated behavior of world bond markets remains a conundrum.

Most long-term interest rates, however, have barely budged despite the appreciable reductions in short-term rates since the beginning of the year. This has led many commentators to ask whether inflation expectations have risen. Surely, one reason long-term rates have held up is changed expectations in the Treasury market, as forecasts of the unified budget surplus were revised down, indicating that the supplies of outstanding marketable Treasury debt are unlikely to shrink as rapidly as previously anticipated. Beyond that, it is difficult to judge whether long-term rates have held up because of firming inflation expectations or a belief that economic growth is likely to strengthen, spurring a rise in real long-term rates.