centralbanking.2013

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Low World Real Interest Rates and theChallenges for Central Banking

Steve Ambler, UQAM and RCEA

CEA Montreal, May 2013
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Ten-Year Government of Canada Bond Yield
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Introduction

Martin Wolf (FT, 19/03/2012): The real interest rate on USand UK government debt is currently near to zero. This is aremarkable fact. True, real interest rates were negative in the1970s. But it is extremely unlikely that anybody bought

bonds expecting this to be the case.
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Introduction


bonds expecting this to be the case. What does it mean to return to normal levels of policy

rates?


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Introduction



rates?

What might by a coherent framework for analyzing low real

rates ?


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Introduction



rates?

What might by a coherent framework for analyzing low real

rates ? r + .


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Rogoff (2012)

Summarizes three main factors explain low real interest rates.1. Global savings glut.


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Rogoff (2012)


Savings for retirement in Japan and Germany.
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Rogoff (2012)


Savings for retirement in Japan and Germany. Demand for bonds by Chinese government.


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Rogoff (2012)



2. Low policy rates to combat the financial crisis.


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Rogoff (2012)



2. Low policy rates to combat the financial crisis.3. Fears of a global financial meltdown => flight to safety.
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Problems

1. Possible to analyze this w/ supply and demand curves forsavings/investment as a function of real interest rate.
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Problems


2. Partial equilibrium analysis.
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Problems


2. Partial equilibrium analysis.3. Doesnt allow for an analysis of the neutral rate within the

framework of the type of New Keynesian model used bycentral banks.
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Problems

1. I take it as given that it would be desirable for central banksmain projection/policy analysis frameworks to be able togenerate, endogenously, the current value of the natural realinterest rate.
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Problems


2. Conceptually easy: the ex ante real interest rate that themodel would generate in the absence of nominal rigidities.


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Problems



3. Problem: the New Keynesian models used by central bankshave (for the most part) representative households.


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Problems



3. Problem: the New Keynesian models used by central bankshave (for the most part) representative households.

4. The models predict a real interest rate close to(1 + r) = (1+g)

.

Wh i i ?
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Whats missing?

Falling birth rates.

Wh i i ?
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Whats missing?


Longevity shocks.

Wh t i i ?
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Whats missing?


Longevity shocks. Great Stagnation.

Bi th t


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Birth rates

Bi th ates
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Birth rates

1. Demographic transition in some countries, eg. Iran, has beenmuch faster than anyone predicted (cf. David Goldman).

Birth rates
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Birth rates

1. Demographic transition in some countries, eg. Iran, has beenmuch faster than anyone predicted (cf. David Goldman).

2. Several countries are moving from youthful populations tosenescence without passing through industrialization.

Longevity


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Longevity

Longevity
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Longevity

1. Oppers et al. (2012): The large costs of aging are beingrecognized, including a belated catch-up to the currently

expected increases in average human life spans. The costs oflongevity risk unexpected increases in life spans are notwell appreciated, but are of similar magnitude.

Great Stagnation


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Great Stagnation

What is Needed
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What is Needed

1. Easy to understand the quantitative implications of theseshocks.

What is Needed
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What is Needed


2. Hard to get a quantitative handle on them.

What is Needed
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What is Needed



3. DGE model of world economy with realistic demographicassumptions and the possibility for sensitivity analysisconcerning tfp growth?

What is Needed
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What is Needed



3. DGE model of world economy with realistic demographicassumptions and the possibility for sensitivity analysisconcerning tfp growth?

4. The Holy Grail of backing out the natural real interest ratefrom the main forecasting/policy analysis model is not in

sight.


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Cochrane (2012): The Fed has crossed a bright line.Open-market operations do not have direct fiscal consequences, ordirectly allocate credit. That was the price of the Fedsindependence, allowing it to do one thing conduct monetary

policy without short-term political pressure. But an agency thatallocates credit to specific markets and institutions, or buys assetsthat expose taxpayers to risks, cannot stay independent of elected,and accountable, officials.
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