The Effect of Globalization on Long-Term Inflation Expectations within the Term Structure of Treasury Interest Rates

This research examined the effect of increased globalization on decreasing long-term inflation expectations, which may, in turn, affect the reliability of the U.S. Federal Reserve Bank's conventional monetary policy (MP). Current MP relies on short-term interest rate manipulations in affecting long-term interest rates and the domestic economy. Researchers detected a de-coupling of long-term interest rates from short-term interest rates, as indicated in the term structure of the Treasury yield curve and as described by the segmented market hypothesis. The decline in inflation expectations, a determinant of interest rates, is a factor in the reduced level of long-term interest rates. If long-term interest rates respond independently from MP's short-term interest rate applications, the extent to which the Federal Reserve Bank can influence the domestic economy may be compromised. Consequently, the availability of foreign assets in domestic markets may be a contributing factor in the decrease on inflation expectations rates. Using data from the period 1982 to 2011, this study utilized unlagged and lagged time series models to ascertain the response of long-term inflation expectations to the global factors of foreign direct flow of investments, and goods and services, as well as the domestic factors of the federal budget and M2 money supply. Analysis of the global predictor variables indicates that imports are statistically significant in both unlagged and lagged models (p < .001) while foreign direct inflows are not statistically significant in any model used in the process (p > .05). The unlogged models (adjusted R2 = .67) indicate statistical significance in all predictor variables, except foreign direct investments, at a 95% Cl ( p < .05) and at a 99% Cl (p < .001) for imports and federal budget and M2 at a 95% Cl (p < .50) in the lagged model (adjusted R2 = .71). The results of the study indicated the presence of first order serial correlation which was analyzed by the use of the Durbin-Watson test (ranging from .67 and .71, without auto-regressive terms). Future studies will require a re-evaluation of the calculations and definitions of predictor variables, in addition to the inclusion of an indicator for monetary policy inflation targeting.