Today, Federal Reserve Chairman Alan Greenspan on Wednesday played down the risk to U.S. bond markets if heavy official foreign buying dried up. Paul Kasriel (Northern Trust Company) has a thought about what would really happen if foreign demand were to fall:
“In effect, the Fed would monetize the U.S. government securities being sold by foreign central banks. Although this would prevent short-maturity interest rates from rising, it might actually lead to higher longer-maturity interest rates. Why? Because the Fed’s monetizing of debt has future inflationary implications. Rising inflation expectations would drive up the nominal interest rates on longer-maturity debt.
So, Greenspan is only partially correct about the effect of foreign central bank sales of U.S. government securities. These sales would not necessarily drive up short-term interest rates, but would probably drive up long-term interest rates.”
