Title: Natural rate chimera and bond pricing reality
Authors: Claus Brand - ECB (Germany)
Wolfgang Lemke - European Central Bank (Germany)
Gavin Goy - De Nederlandsche Bank (Netherlands) [presenting]
Abstract: Taking into account secular macroeconomic trends, the decline in yields observed since the 1980s appears more due to a fall in equilibrium interest rates and less to a decline in term premia than typically reported. We incorporate an arbitrage-free term-structure model into a small semi-structural macro-model to jointly estimate potential output growth, output gaps, core inflation, real equilibrium interest rates, and term premia (for the US and the euro area). We illustrate that exploiting cross-sectional information in yields and closing the original macro-model with a short-rate equation increases the precision of natural rate estimates. We use a Bayesian approach to estimate all model components simultaneously. Taking into account the secular fall in equilibrium rates, term premia exhibit cyclical behavior over the business cycle, rather than a trend decline.