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Debt-Secular Economic Changes and Bond Yields

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  • Bruno Feunou
  • Jean-Sébastien Fontaine

Abstract

We build a model for bond yields based on a small-scale representation of an economy with secular declines in inflation, the real rate and output growth. Long-run restrictions identify nominal shocks that influence long-run inflation but do not influence the long-run real rate or output growth. These nominal shocks have loadings that can change over time. The results show that, before the anchoring of inflation around the mid-1990s, nominal shocks lifted the output gap and inflation, leading to higher yields and a steeper yield curve via higher short-rate expectations and term premiums. The short rate peaked after several quarters but only after the responses of growth and inflation started to decline. With inflation anchored, however, nominal shocks have a short-lived impact on inflation, an insignificant impact on output and only a small impact on bond yields via the term premium.

Suggested Citation

  • Bruno Feunou & Jean-Sébastien Fontaine, 2021. "Debt-Secular Economic Changes and Bond Yields," Staff Working Papers 21-14, Bank of Canada.
    • Handle: RePEc:bca:bocawp:21-14
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    More about this item

    Keywords

    Asset pricing; Econometric and statistical methods; Interest rates; Monetary policy and uncertainty; Potential output;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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