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

Jens Christensen, Glenn Rudebusch and Patrick Shultz

No 2020-35, Working Paper Series from Federal Reserve Bank of San Francisco

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.

Keywords: affine arbitrage-free term structure model; liquidity risk; financial market frictions; r-star (search for similar items in EconPapers)
JEL-codes: C32 E43 E52 G12 G17 (search for similar items in EconPapers)
Pages: 72
Date: 2020-11-19
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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DOI: 10.24148/wp2020-35

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