Decline In Real Interest Rates Research Articles

Machine learning modeling to forecast uncertainty between capital sudden stop and boom

In emerging economies, sudden stops of capital inflows boost the collapse of stock and exchange rate markets and plunge countries into unemployment, loss of production, and diminishing exports, leading to a financial crisis. Recently, the nonlinear relationship-based machine learning (ML) model for analyzing the complexity and uncertainty of financial and economic systems has been in the spotlight, but they are still poorly used for predicting sudden stops of capital. Because there is no verified tool that elaborately measures the indicia of rapid suspension or expansion of capital for prediction purposes, ML models learned from domains with inadequately defined economic characteristics of capital movements can suffer from poor predictive power and reliability. In addition, many economists do not trust the ML model due to the lack of interpretability caused by the black box structure of ML models. In this study, three approaches are proposed for better prediction and decision-making. First, using data for 37 emerging economies from 1990 to 2019, we apply various ML techniques such as extreme gradient boost (XGB), which is well known for the latest ensemble learning technology. Second, we analyze the causal relationship to the outcomes of our models using SHAP (SHapley Additive exPlanations) methods, a powerful technique for ML interpretation. Particularly, from the perspective of post-COVID-19, our model predicts an increased probability of sudden stops in countries where a sharp decline in real interest rates and exports is evident. Finally, we propose a tool to measure capital flows and assess excessive levels for forecasting purposes. Particularly, our tool extracts credit boom events that are highly correlated with sudden stops, and the ML models with credit boom events have significantly improved predictive performance. Specifically, in the forecast of a sudden stop after one year, the prediction accuracy of the models with a credit boom event is improved by 11.2% on average compared to models without credit boom information. In addition, the gap between the predicted hit and the miss rate in the proposed models was reduced to −16.2% on average compared to the original, improving the balance of classification.

Understanding Swiss real interest rates in a financially globalized world

This paper proposes long-run estimates of ex ante real interest rates in Switzerland and other developed economies, and it describes their relative evolution. Our results highlight the decline in—and convergence of—global real interest rates that has unfolded over the last three decades for all maturities. While Swiss yields stand out as being particularly low and stable from a historical perspective, we find that Swiss interest rates have fallen less than in many other countries during the last decade. We then examine whether the reduction in the interest differential is related to a lower attractiveness of the Swiss franc. Focusing on the difference of Swiss minus German real government bonds yields, we find a significant increase in expected real depreciation of the Swiss franc and a somewhat lower convenience yield for Swiss bonds—the convenience yield reflecting the non-pecuniary value that investors impute to the liquidity of a given bond. In contrast, the safety premium in favor of the Swiss franc increased and therefore cannot explain the smaller decline in real interest rates in Switzerland. The last part of the paper analyzes the negative convenience yield on Swiss government bonds and its recent decline. We show that both the purchase of government bonds by foreign central banks and foreign exchange interventions by the Swiss National Bank may have contributed to this decline by reducing the relative supply of foreign versus domestic government bonds.

The Natural Rate of Interest Through a Hall of Mirrors

Prevailing explanations of persistently low interest rates appeal to a secular decline in the natural interest rate, or r-star, due to factors outside monetary policy's control. We propose informational feedback via learning as an alternative explanation for persistently low rates, where monetary policy plays a crucial role. We extend the canonical New Keynesian model to an incomplete information setting where the central bank and the private sector learn about r-star and infer each other's information from observed macroeconomic outcomes. An informational feedback loop emerges when each side underestimates the effect of its own action on the other's inference, possibly leading to large and persistent changes in perceived r-star disconnected from fundamentals. Monetary policy, through its influence on the private sector's beliefs, endogenously determines r-star as a result. We simulate a calibrated model and show that this `hall-of-mirrors' effect can explain much of the decline in real interest rates since 2008.

Government Debt and Capital Accumulation in an Era of Low Interest Rates

This essay discusses the reasons for and implications of the decline in real interest rates around the world over the past several decades. It suggests that the decline in interest rates is largely explicable from trends in saving, growth, and markups. In this environment, greater government debt is likely not problematic from a budgetary standpoint. But a Ponzi-like scheme of perpetual debt rollover might fail, and such a failure would make a bad state of the world even worse. In addition, even if a perpetual debt rollover succeeds, the increased debt could still crowd out capital, reducing labor productivity, real wages, and consumption.

Average Inflation Targeting in a Low-Rate Environment

One significant change in the US economy in the last 20 years is the trend decline in real interest rates that pushes the policy rate near the effective lower bound (ELB) and puts downward pressure on inflation. This environment leaves conventional monetary policy tools less effective in accommodating adverse shocks. To better achieve the Federal Reserve’s dual mandate at the ELB, the FOMC adopted a new framework called average inflation targeting (AIT). In this Commentary, I demonstrate that AIT is a better policy in a low-rate environment because of its ability to anchor inflation expectations, and I present possible implications of the flexible implementation of AIT.

Kaldor and Piketty’s facts: The rise of monopoly power in the United States

The macroeconomic data of the last fifty years have overturned at least two of Kaldor’s famous stylized growth facts: constant interest rates, and a constant labor share. At the same time, the research of Piketty and others has introduced several new and surprising facts: an increase in the financial wealth-to-output ratio in the US, an increase in measured Tobin’s Q, and a divergence between the marginal and average returns on capital. In this paper, we argue that these trends can be explained by an increase in market power and pure profits in the US economy—that is, the emergence of a non-zero-rent economy—along with forces that have led to a persistent long-term decline in real interest rates. We make three parsimonious modifications to the standard neoclassical model to explain these trends. Using recent estimates of the increase in markups and the decrease in real interest rates, we show that our model can quantitatively match these new stylized macroeconomic facts.

Financial and Total Wealth Inequality with Declining Interest Rates

Financial wealth inequality and long-term real interest rates track each other closely over the post-war period. Faced with unanticipated lower real rates, households which rely more on financial wealth must see large capital gains to afford the consumption that they planned before the decline in rates. Lower rates beget higher financial wealth inequality. Inequality in total wealth, the sum of financial and human wealth and the relevant concept for house-hold welfare, rises much less than financial wealth inequality and even declines at the top of the wealth distribution. A standard incomplete markets model reproduces the observed in-crease in financial wealth inequality in response to a decline in real interest rates because high financial-wealth households have a financial portfolio with high duration.

Financial and Total Wealth Inequality with Declining Interest Rates

Financial wealth inequality and long-term real interest rates track each other closely over the post-war period. Faced with unanticipated lower real rates, households which rely more on financial wealth must see large capital gains to afford the consumption that they planned before the decline in rates. Lower rates beget higher financial wealth inequality. Inequality in total wealth, the sum of financial and human wealth and the relevant concept for house-hold welfare, rises much less than financial wealth inequality and even declines at the top of the wealth distribution. A standard incomplete markets model reproduces the observed in-crease in financial wealth inequality in response to a decline in real interest rates because high financial-wealth households have a financial portfolio with high duration. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Real Interest Rate Shocks and Portfolio Strategy

Fluctuations in real interest rates affect every aspect of an investment program, including the present value of the liability, as well as the returns on each asset class. We review the history and causes of real interest rate fluctuations using a nonmathematical <i>very simple macro model</i>, then assess the risks to each major asset class (and also to liabilities) from likely changes in the real rate. The objective is to help investors defend their portfolios against this important risk. An appendix provides deep history, showing that real interest rates have declined over very long periods of time as markets and political institutions have become more developed. <b>TOPICS:</b>Real estate, commodities, real assets/alternative investments/private equity, currency, private equity <b>Key Findings</b> • Rapidly rising real rates pose a substantial risk to the whole portfolio, through both fixed income and equity assets. Although the risk posed to fixed income is direct and mechanical, the risk posed to equities and alternative assets is complex and subtle. • This asset-side risk may be offset, to a greater or lesser degree, depending on the real interest rate duration of the liability, by a decrease in liability valuation due to rising real rates (again, depending on duration). • The risk of a decline in real interest rates comes from the opportunity-cost of being out of a rising bond fixmarket. Many investors, leery of the potential for rising rates, have shortened the duration of their holdings and would not participate to a satisfactory extent if a bond rally were to occur due to rates falling further.

POPULATION AGING AND THE REAL INTEREST RATE IN THE LAST AND NEXT 50 YEARS: A TALE TOLD BY AN OVERLAPPING GENERATIONS MODEL

Population aging, along with a secular decline in real interest rates, is an empirical regularity observed in developed countries over the last few decades. Under the premise that population aging will deepen in coming years, some studies predict that real interest rates will continue to be depressed further to a level below zero. In this paper, we address this issue and explore how changes in demographic structures have affected and will affect real interest rates, using an overlapping generations model calibrated to Japan’s economy. We find that the demographic changes over the last 50 years reduced the real interest rate. About 270 out of the 640 basis points decline in real interest rates during this period was due to declining labor inputs and higher saving, which themselves stemmed from the lower fertility rate and increased life expectancy. As for the next 50 years, we find that demographic changes alone will not substantially increase or decrease the real interest rate from the current level. These changes reflect the fact that the size of demographic changes in years ahead will be minimal, but that downward pressure arising from the past demographic changes will continue to bite. As Japan is not unique in terms of this broad picture of changes in demographic landscapes in the last and next 50 years, our results suggest that, sooner or later, a demography-induced decline in real interest rates may be contained in other developed countries as well.

Long-Term Growth and Productivity Trends: Secular Stagnation or Temporary Slowdown?

Economic growth in advanced countries has slowed in successive stages since the 1970s and, since the crisis, has fallen to a historical low compared with the 20th century. This slowdown is mainly attributable to weaker growth in total factor productivity. In emerging countries, the situation varies: in some countries, such as South Korea and Chile, GDP per capita have been converging for several decades; in others, such as Argentina, Brazil and Mexico, relative GDP per capita has stagnated or even declined. While weak long-term growth in these latter countries can be attributed to a lack of appropriate institutions, the widespread slowdown observed in advanced countries is more difficult to interpret. One possible explanation that we explore is the decline in real interest rates since the 1990s. A circular relationship appears to exist between interest rates and productivity: productivity determines long-term returns on capital and thereby interest rates; interest rates in turn determine the minimum productivity expected from investment projects. The decline in real interest rates, which is in part attributable to demographic factors, may have led to a slowdown in productivity by making an increasing number of unproductive companies and projects profitable. We illustrate this circular relationship using a cross-country panel regression. One way of breaking out of the circular relationship would be via a new technological revolution linked to the digital economy, or, in countries where there is still room for convergence, via structural reforms to improve the diffusion of Information and Communication Technologies (ICT).

Discussion

Discussion

TWO APPROACHES TO MODELING UNCERTAINTY: HOW DID UNCERTAINTY AFFECT THE ECONOMY DURING AND AFTER THE GREAT RECESSION?

Recent research in macroeconomics has sought to develop a tractable form of heterogeneity in attempting to model sluggish responses in the price level. In addition, economists have struggled to explain why the demand for safe assets has increased as evidenced by the decline in real interest rates and even nominal interest rates in the last three decades [King, M (2017). Uncertainty and large swings in activity. In National Bureau of Economic Research Martin Feldstein Lecture, Cambridge, MA: NBER Summer Institute; King, M and D Low (2014). Measuring the ‘World’ Interest Rate. National Bureau of Economic Research Working Paper 19887, Cambridge, MA]. We build a simple two-period lived overlapping generations model that displays both heterogeneity of expectations and robustness. Our goal is to derive the economic impacts associated with greater uncertainty; more specifically, to answer the question can these two versions of uncertainty account for an increase in the demand for money and the low return on safe assets? Since analysis of even such a simple model requires a lot of technical work, we put most of this technical work into a rather lengthy technical Appendix for the benefit of readers who wish to follow such details. The main text in the paper will just focus on the basic economics.

On the source of U.S. trade deficits: Global saving glut or domestic saving drought?

Are U.S. trade deficits caused by high foreign saving—a global saving glut—or low domestic saving—a domestic saving drought? To answer this question, I conduct a wedge accounting analysis of U.S. trade balance dynamics during 1995–2011 using a dynamic general equilibrium model. I find that a global saving glut explains 96 percent of U.S. trade deficits in excess of those that would have occurred naturally as a result of productivity growth and demographic change. Contrary to widespread belief, however, investment distortions, not a global saving glut, account for much of the decline in real interest rates that has accompanied U.S. trade deficits.

Do the Bank of Japan’s Unconventional Monetary Policies Decrease Real Interest Rates under a Zero Lower Bound?

To test Paul Krugman’s pioneering proposal for escaping from liquidity traps, this study examines whether unconventional monetary policies under a zero lower bound decrease real interest rates in Japan. We find a sizable decline in real interest rates under zero interest rate policy and Abenomics monetary policy. In addition, we find no significant decline in real interest rates under other unconventional monetary policies, such as the first quantitative easing and comprehensive monetary easing.

Why Have Interest Rates Fallen Far Below the Return on Capital

Risk-free rates have been falling since the 1980s. The return on capital, defined here as the profits over the stock of capital, has not. We analyze these trends in a calibrated OLG model designed to encompass many of the usual suspects cited in the debate on secular stagnation. Declining labor force and productivity growth imply a limited decline in real interest rates and deleveraging cannot account for the joint decline in the risk free rate and increase in the risk premium. If we allow for a change in the (perceived) risk to productivity growth to fit the data, we find that the decline in the risk-free rate requires an increase in the borrowing capacity of the indebted agents in the model, consistent with the increase in the sum of public and private debt since the crisis but at odds with a deleveraging-based explanation put forth in Eggertsson and Krugman (2012).

Why so Low for so Long? A Long-Term View of Real Interest Rates

Prevailing explanations of the decline in real interest rates since the early 1980s are premised on the notion that real interest rates are driven by variations in desired saving and investment. But based on data stretching back to 1870 for 19 countries, our systematic analysis casts doubt on this view. The link between real interest rates and saving-investment determinants appears tenuous. While it is possible to find some relationships consistent with the theory in some periods, particularly over the last 30 years, they do not survive over the extended sample. This holds both at the national and global level. By contrast, we find evidence that persistent shifts in real interest rates coincide with changes in monetary regimes. Moreover, external influences on countries' real interest rates appear to reflect idiosyncratic variations in interest rates of countries that dominate global monetary and financial conditions rather than common movements in global saving and investment. All this points to an underrated role of monetary policy in determining real interest rates over long horizons.

Global Interest Rate Environment with Emphasis on Quantitative Easing Implications

Constructing global real interest rates at short and long maturities and reviews their evolution since 1980. It also traces the evolution of the cost of capital, It then analyzed key factors that could explained the observed pattern, shift in savings, changes in monetary and fiscal policy, shift in investment demand, changes in relative prices of investment, monetary policy and portfolio shifts between bonds and equity. It closes by considering how the main factors behind the decline in real interest rates might play out in the medium term. Real interest rates and the cost of capital are likely to rise moderately in the medium term from current level. Part of the reason is cyclical, the extremely low real interest rates of recent years reflects large negative output gaps in advanced economies. Indeed, the real interest rates might have declined even further in the absence of the zero lower bound on nominal interest rate.

The Economic Consequences of 'Market-Based' Lending

The growth of “market-based” lending is closely related to the growth of repurchase agreements and similar contracts that grant the lender the right to sell collateral on the market if a threshold level of over-collateralization is not maintained. This paper argues that this contractual structure relies so heavily on market liquidity that its ubiquitous use has the paradoxical effect of disrupting market liquidity itself. The paper takes a Keynesian view of market liquidity as prone to crises of confidence and thus fundamentally unstable. It develops an analytic framework that explains how the economic function of the traditional banking system is to act as a shock absorber for the liquidity crises that are inherent to markets. The growth of “market-based” lending and in particular its culmination in the development of a money market that is dominated by repurchase agreements and other collateralized instruments is analyzed using this framework.This paper argues that the growth of repurchase and margin contracts has created an environment where liquidity crises are endemic. In this environment even in normal times market participants seek to self-insure by holding “safe haven” assets that are unlikely to fall in value in a liquidity crisis. Thus, this structural shift in the financial system explains (i) the decline in real interest rates that started in the late 1990s, (ii) the increase in the spreads between “safe” and riskier assets, and (iii) the lackluster economic performance that has led to concerns about secular stagnation.

The pre-Great Recession slowdown in productivity

In the years since the Great Recession, many observers have highlighted the slow pace of productivity growth around the world. For the United States and Europe, we highlight that this slow pace began prior to the Great Recession. The timing thus suggests that it is important to consider factors other than just the deep crisis itself or policy changes since the crisis. For the United States, at the frontier of knowledge, there was a burst of innovation and reallocation related to the production and use of information technology in the second half of the 1990s and the early 2000s. That burst ran its course prior to the Great Recession. Continental European economies were falling back relative to that frontier at varying rates since the mid-1990s. We provide VAR and panel-data evidence that changes in real interest rates have influenced productivity dynamics in this period. In particular, the sharp decline in real interest rates that took place in Italy and Spain seem to have triggered unfavorable resource reallocations that were large enough to reduce the level of total factor productivity, consistent with recent theories and firm-level evidence.