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Accounting for Low Long-Term Interest Rates: Evidence from Canada

Author

Listed:
  • Jens H. E. Christensen
  • Glenn D. Rudebusch
  • Patrick Shultz

Abstract

In recent decades, long-term interest rates around the world have fallen to historic lows. We examine this decline using a dynamic term structure model of Canadian nominal and real yields with adjustments for term, liquidity, and inflation risk premiums. Canada provides a useful case study that has been little examined despite its established indexed debt market, negligible distortions from monetary quantitative easing or the zero lower bound, and no sovereign credit risk. We find that since 2000, the steady-state real interest rate has fallen by more than 2 percentage points, long-term inflation expectations have edged down, and real bond and inflation risk premiums have fluctuated but shown little longer-run trend. Therefore, the drop in the equilibrium real rate appears largely to account for the lower new normal in interest rates.

Suggested Citation

  • Jens H. E. Christensen & Glenn D. Rudebusch & Patrick Shultz, 2020. "Accounting for Low Long-Term Interest Rates: Evidence from Canada," Working Paper Series 2020-35, Federal Reserve Bank of San Francisco.
    • Handle: RePEc:fip:fedfwp:89093
    DOI: 10.24148/wp2020-35
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    More about this item

    Keywords

    affine arbitrage-free term structure model; liquidity risk; financial market frictions; r-star;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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