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Staff Reports

Is There Hope for the Expectations Hypothesis?

Number 1098
April 2024 Revised November 2024

JEL classification: D84, E43, G12

Authors: Richard K. Crump, Stefano Eusepi, and Emanuel Moench

Most macroeconomic models impose a tight link between expected future short rates and the term structure of interest rates via the expectations hypothesis (EH). While systematically rejected in the data, existing work evaluating the EH generally assumes either full-information rational expectations or stationarity of beliefs, or both. As such, these analyses are ill-equipped to refute the EH when these assumptions fail to hold, leaving the door open for a “resurrection” of the EH. We introduce a model of expectations formation which features time-varying means and accommodates deviations from rationality. This model tightly matches the entire joint term structure of expectations for output growth, inflation, and the short-term interest rate from all surveys of professional forecasters in the U.S. We show that deviations from rationality and drifting long-run beliefs consistent with observed measures of expectations, while sizable, do not come close to bridging the gap between the term structure of expectations and the term structure of interest rates. Not only is the EH decisively rejected in the data, but model-implied short-rate expectations generally display, at best, only a weak co-movement with the forward rates of corresponding maturities.

Full Article

Author Disclosure Statement(s)

Richard Crump
I declare that I have no relevant or material financial interests that relate to the research described in my paper entitled “Is There Hope for the Expectations Hypothesis?,” joint with Stefano Eusepi and Emanuel Moench. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index.html.

Stefano Eusepi
I declare that I have no relevant or material financial interests that relate to the research described in my paper entitled “Is There Hope for the Expectations Hypothesis?,” joint with Richard Crump and Emanuel Moench.

Emanuel Moench
I declare that I have no relevant or material financial interests that relate to the research described in my paper entitled “Is There Hope for the Expectations Hypothesis?,” joint with Richard Crump and Stefano Eusepi.

Suggested Citation:
Crump, Richard K., Stephano Eusepi, and Emanuel Moench. 2024. “Is There Hope for the Expectations Hypothesis?” Federal Reserve Bank of New York Staff Reports, no. 1098, April. https://doi.org/10.59576/sr.1098

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