Explanation Of The Disappearance Of R~2 Value Based On Viscous Expectation Theory

The premise of the traditional interest rate transmission channel is that there is a stable co-direction relationship between the long-term and short-term interest rates.But Thornton(2012)found that the value of interest rate R~2,which is equal to the square of the correlation coefficient between long-term and short-term interest rates,fell to zero in the early 1990s and has remained at that level ever since.Why did the co-directional relationship between short and long-term interest rates change in the early 1990s and the effectiveness of traditional interest rate transmission channels disappear?Through further decomposition of the relationship between long-term and short-term interest rates,this paper grasps the key variable of public short-term interest rate expectation.This paper uses sticky expectation theory to analyze the formation mechanism of public short-term interest rate expectation,and constructs an empirical model based on Carroll(2001)epidemic model to verify it.The study finds that,because of the cost of information,the public will not update all the information in real time,but will predict it partly based on past information,so the public's short-term interest rate expectation is a sticky expectation.When the public's short-term interest rate expectation is viscous,the impact or determinants of real short-term interest rate and short-term interest rate expectation are partly the same,and there is a certain degree of co-directional change between them.Therefore,the stickiness of expectation is the premise of the existence of interest rate R~2 value and the effectiveness of traditional interest rate transmission channels.The information revolution led the Federal Reserve to change its monetary policy operation mode in the early 1990s.The viscous degree of public expectations decreased significantly.The co-directional link between real short-term interest rate and short-term interest rate expectations broke down,and the traditional interest rate transmission channel was no longer effective.This also explains why today's Federal Reserve pays more attention to communication with the public,emphasizing the regulation of long-term interest rates by guiding the public's short-term interest rate expectations.