R* an and t the G Glob obal E Economy y Reuven Glick Federal Reserve Bank of San Francisco Conference on ” Global Safe Assets, International Reserves, and Capital Flow” City University of Hong Kong and Journal of international Money and Finance May 20-21, 2019 Disclaimer: The views presented are mine alone and do not necessarily represent the views of the Federal Reserve Bank of San Francisco or the Board of Governors of the Federal Reserve System. 1
Navigating by the Stars π *, g*, u*, … r* 2
One explanation for declining interest rates 3
Other explanations for declining r* • Supply-side phenomena: lower productivity growth, aging populations • Demand-side phenomena: insufficient demand, secular stagnation • Portfolio preference shifts, growing global safe asset demand 4
Outline o Estimates of r* in U.S. and abroad o Possible Drivers of r * Saving-investment balance Safe asset supply and demand o Empirical evidence Saving, investment factors Asset preferences, foreign demand for U.S. assets o Implications for U.S. monetary policy 5
U.S. real rates have been falling U.S. Real 10-year and 3-month Treasury Yields (%) 10 8 6 4 2 0 -2 -4 1980 1985 1990 1995 2000 2005 2010 2015 10-yr TB - 10-yr infl (SPF) 10-yr TIPS 3-mo TB - 1-yr infl (SPF) 6
Estimated r* in U.S. has been falling Estimates of r* for the U.S. (%) 5 4 3 2 1 0 -1 1980 1985 1990 1995 2000 2005 2010 2015 Laubach-Williams Holston-Laubach-Williams Kiley Johanssen-Mertens Del Negro et al Lubik-Matthes AVERAGE zero line 7
r* in other countries has fallen as well Estimates of r* in Advanced Countries (%) 5 4 3 2 1 0 -1 1980 1985 1990 1995 2000 2005 2010 2015 Canada Euro Area U.K. U.S. average 8 Source: updated figures from Holston et al. (2017) and FRBNY website.
Saving and Investment Balance Approach to Determining r* Interest rate, r S + S f . A r o = r* r o when y = y*, y f = y f * I+ I f Global saving, S + S f Global investment, I + I f 9
Saving increase or investment decline lowers equilibrium interest rate Effects of Saving Increase and Investment Decline on Interest Rate Interest rate, r Interest rate, r S + S f S + S f A . r o A . r o . r 1 . B r 1 I+ I f B I I + I f Global saving, S + S f Global saving, S + S f Global investment, I + I f Global investment, I + I f 10
Possible drivers of declining r* Factors increasing saving Factors decreasing investment • Demographics: Longer lifer • Demographics: Slower labor force expectancy, lower dependency growth burdens • Lower productivity growth • Rising inequality • Reduced investment profitability • Excess foreign saving • Declining competition • Greater risk aversion, portfolio shift towards safer assets 11
Life expectancy increasing, labor force growth falling in advanced countries OECD Life Expectancy (years) and Labor Force Growth (%) 90 1.60 1.40 88 Projections 86 1.20 84 1.00 82 0.80 80 0.60 78 0.40 Life Expectancy (years, left scale) 76 0.20 Labor force growth (%, right scale) 74 0.00 72 -0.20 70 -0.40 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 12
Potential output growth falling in advanced countries Trend Output Growth in Advanced Countries (%) 5 4 3 2 1 0 1980 1985 1990 1995 2000 2005 2010 2015 Canada Euro Area U.K. U.S. average Source: updated figures from Holston et al. (2017) and FRBNY website. 13
Excess foreign saving decreases domestic interest rate Global Imbalances and the Interest Rate Interest rate, r Interest rate, r S S f A . r o CA surplus . B . C . . r 1 r 1 C’ B’ I . CA deficit f r o A’ I f Foreign saving, S f Domestic saving, S Foreign investment, I f Domestic investment, I 14
Excess saving in developing countries in 2000s Advanced and Developing Country Saving and Investment (% of GDP) 35 S developing 30 I developing 25 S advanced 20 I advanced 15 10 1980 1985 1990 1995 2000 2005 2010 2015 15
Saving & investment factors contributed to decline in r* Decline in r* Decomposed (bps ) 600 More fiscal spending, debt 400 Unexplained 200 Higher foreign saving 0 Interactions -200 Lower y*, productivity -2.7pp Lower investment -400 -4.5pp Higher inequality -600 Demographics: aging,etc. -800 Net decline Rachel and Smith (2017), Rachel and Summers (2019), 30+ yrs, 1980s-2015 40+ yrs, 1970s-2018 16
Safe Asset Approach to Determining r* Equilibrium Safe Interest Rate Safe interest rate, r D+ D f A r o = r* . r o when y = y*, y f = y f * S + S f Global supply of safe assets, S + S f Global demand for safe assets, D+ D f 17
Properties of safe assets Provide • Security, i.e. pay close to par in the future • Liquidity, i.e. money-like in availability and acceptability Play parallel roles to money: • Transaction role by serving as collateral in financial transactions and regulatory capital in meeting liquidity requirements, • Accessible store of value role by providing a reliable return • Accounting role by serving as a benchmark for the pricing of other assets 18
Who supplies safe assets? • Governments: e.g. Treasury securities, currency, central bank reserves • Private financial sector: deposits, commercial paper, asset-backed securities Note: Governments may enhance the security of privately-created assets by providing guarantees, e.g. deposit insurance for bank deposits. Safe assets are not all perfect substitutes in terms of their liquidity or safety properties. “Frontier” between safe and unsafe assets can be sensitive to changes in perceptions of security, credit quality (Gourinchas& Jeanne) 19
Possible drivers of declining r* for safe assets Factors increasing demand Factors decreasing supply • Economic growth • Decreased credit quality of government or private safe assets • Greater precautionary demand • Fiscal austerity that reduces supply of • Regulatory reform that increases government asset issuance demand for high-quality collateral 20
Caballero et al. view of the world: Global shortage of safe assets lowers interest rate Effect on Safe Rate r if Demand Increases More Than Supply Safe interest rate, r D+ D f . A r o . B r 1 S + S f I Global supply of safe assets, S + S f Global demand for safe assets, D + D f 21
Caballero et al. view of the world: Global shortage of safe assets lowers interest rate Effect on Safe Rate r if Demand Increases More Than Supply Safe interest rate, r D+ D f Financial crisis effect ? . A r o . B r 1 S + S f I Global supply of safe assets, S + S f Global demand for safe assets, D + D f 22
Determination of Safe Rate in “General Equilibrium” Caballero, Farhi, Gourinchas, AER, 2016 ) : S = β + α y + αr ( Safe Asset Equilibrium SA y + θ(y - y ) target * ( ) : r = r Taylor Rule TR : y = y - δ(r - r ) - δ (r -r ) * * * IS curve r r r Safe asset interest, r Taylor rule (TR) : r =r target + θ(y -y * ) _ A . r* = r target _ Safe Asset equilib. (SA) : S = β + α y y + α r _ == > r = ( S - β - α y y)/ α 23 y = y * Output, y
Determination of Safe Rate in “General Equilibrium” Caballero, Farhi, Gourinchas, AER, 2016 ) : S = β + α y + αr ( Safe Asset Equilibrium SA y + θ(y - y ) target * ( ) : r = r Taylor Rule TR : y = y - δ(r - r ) - δ (r -r ) * * * IS curve r r r Safe asset interest, r Taylor rule (TR) : r =r target + θ(y -y * ) r* declines in response _ to decline in supply S or A . rise in demand β r* = r target _ Safe Asset equilib. (SA) : S = β + α y y + α r _ == > r = ( S - β - α y y)/ α 24 y = y * Output, y
Empirical Evidence • Price-based evidence : Rate spreads Risk premia • Quantity-based evidence : Holdings of government and private-provided safe U.S. assets by domestic and foreign sectors 25
Are Bond Spreads Rising? Del Negro et al. vs. Rachel and Summers U.S. Bond Spreads (%) 6 5 4 3 2 1 0 -1 1980 1985 1990 1995 2000 2005 2010 2015 AAA - TB20 BAA - TB20 26
Are Bond Spreads Rising? Del Negro et al. vs. Rachel and Summers U.S. Bond Spreads (%) 6 5 Are spreads rising? 4 3 2 1 0 -1 1980 1985 1990 1995 2000 2005 2010 2015 AAA - TB20 BAA - TB20 27
Equity premium increasing since late 1990s U.S. 10-year Treasury Bond Rate 25% and Expected Equity Return 20% Since late 1990s, the expected equity return has been constant, while Treasury rate has continued to decline 15% Equity return 10% Equity premium 5% 10-year Treasury rate 0% 1980 1985 1990 1995 2000 2005 2010 2015 28
Foreign holdings of U.S. Treasuries rising since 1990s Holdings of U.S. Treasury Securities (bil$) 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 1990 1995 2000 2005 2010 2015 All private and foreign held Foreign held Foreign official held 29 Source: Treasury Bulletin, Treasury International Capital (TIC) reports
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