But, as we all know, long-term rates have actually fallen as the FOMC has raised short-term rates. For example, the benchmark ten-year Treasury rate is down by more than ½ percentage point since the funds rate started heading up in the middle of last year. This is the basis for what Chairman Greenspan has called the bond rate “conundrum” that has commanded so much attention recently. There is a debate about how to interpret the decline in longer term yields and it essentially boils down to whether the surprising behavior of long rates is due to various “special factors” operating  independently of the current business cycle or instead augurs bad economic news on the horizon. If special factors are holding down long term yields, then the total amount of stimulus to spending from interest rates is currently greater than would be surmised on the basis of the current federal funds rate. In effect, unusually low long-term bond rates are now providing extra stimulus to offset the drags I described. A number of “special factors” might be at work to flatten the yield curve. One possibility is that low bond rates reflect a drop in risk premiums because inflation has become better anchored and the volatility of the real economy has fallen. But let me also note that other factors would seem to work in the opposite direction—for example, our large and growing federal budget and trade imbalances could be raising risk premiums.
The danger is that, if we do not proceed with due care, hurried decisions will be made that will be revealed to be poorly conceived the next time the financial system runs aground, which might not occur until decades from now. The other point I wish to make is that the Central Bank of Iceland will do its utmost to ensure that this policy-making process is carried out as meticulously as possible, and its staff have significant expertise on all of these issues. The Bank’s next major contribution to this process will be an in-depth report on Iceland’s options for a currency regime, which will be published this spring or early this summer. 6  BIS central bankers’ speeches  Before I close, I would like to thank the Central Bank’s many collaborators for a successful cooperative relationship over the past year. Particular thanks are due to the ministries with which the Bank works most closely: the Ministry of Economic Affairs and the Ministry of Finance, as well as the Prime Minister’s Office and the Ministry for Foreign Affairs. I would also like to express my gratitude for the cooperation with the Parliament of Iceland, particularly the Economics and Commerce Committee. In addition, I wish to thank the Financial Supervisory Authority for successful collaboration in 2011, the first year of the new cooperation agreement between the two institutions. And last, but certainly not least, I would like to thank the staff of the Central Bank for their work during the year.