Download Long-term interest rates, GDP and inflation in Poland

Do long-term interest rates drive GDP and inflation in
small open economies? Evidence from Poland
by Grzegorz Wesołowski
Comments by Dubravko Mihaljek
Bank for International Settlements
11th Young Economists’ Seminar
Dubrovnik Economic Conference
Dubrovnik, 12 June 2016
The views expressed are those of the presenter and not necessarily those of the BIS.
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Research questions
 Does the term premium in the long-term interest rate
significantly affect the shock propagation mechanism in the SOE?
 Does the term premium significantly impact the volatility of
output gap and inflation in the SOE?
 Did changes in investors' sentiment (eg associated with QE)
affect GDP and inflation in Poland?
 What is the estimated impact of long-term interest rates on GDP
as compared with the impact of short term interest rates in
Poland?
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Answers in the paper
 Does the term premium significantly affect the shock
propagation mechanism in SOEs?
• Seems so, but not clear to me how this works
 Does the term premium significantly impact the volatility of
output gap and inflation in the SOEs?
• In Poland: yes (output gap), no (inflation). But answers differ
for a TP “shock” (no and no)
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Answers in the paper (cont)
 Did changes in investors' sentiment (eg associated with QE)
affect GDP and inflation in Poland?
• No, even though QE lowered long-term IR in Poland
 What is the estimated impact of long-term interest rates on GDP
as compared with the impact of short term interest rates in
Poland?
• 5.1 times bigger effect of short-term IRs
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What is this all about?
Term premium
= Duration risk premium for holding a long-term bond yield: the
compensation investors get for locking up their money for long
stretches rather than constantly rolling it over
Cannot be observed, has to be estimated
Some approaches based solely on term structure models using
bond yields at a range of maturities, without incorporating
macroeconomic variables (eg Adrian et al, 2013)
Other approaches based on the joint estimation of macroeconomic
and term structure models, which allow the effect of
macroeconomic developments to be incorporated (eg Hördahl and
Tristani, 2014)
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Term premia (cont)
Decomposition into term premia and expected interest rates is very tricky
and strongly model-dependent (see also FT Alphaville, 4 Sep 2015)
Term premia in the United States from different models
In per cent
Ten-year term premium
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Ten-year expectations component1
Difference between 10-year nominal zero coupon yield and 10-year estimated term premium.
Sources: Adrian et al (2013); Hördahl and Tristani (2014); Federal Reserve Bank of New York; Bloomberg; BIS; BIS calculations.
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Term premia (cont)
 Both expected future nominal short-term rates and term premia
are currently estimated to be very low.
 TP estimated at close to zero in the United States, and at –1.5%,
in the euro area
 This means that investors are demanding virtually no
compensation for interest rate risk on US government debt
 … and are willing to pay to take on the risk that long-term
interest rates in the euro area will rise
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Bond yield decompositions1
In per cent
Ten-year nominal yield
Ten-year expectations component2
Ten-year term premium
1
The dashed lines represent historical averages for the period 1990–2016 for the United States and 1999–2016 for euro area. 2 Difference
between 10-year nominal zero coupon yield and 10-year estimated term premium. 3 For the euro area, French government bond data are
used.
Sources: Hördahl and Tristani (2014); Bloomberg; BIS calculations.
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More granular bond yield decompositions1
In per cent
Expected real interest rates
1
Expected inflation
Ten-year government bond yields.
2
Real term premium
Inflation risk premium
For the euro area, French government bond data are used.
Sources: Hördahl and Tristani (2014); Bloomberg; BIS calculations.
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Why is all this important for central banks?
Bernanke (Economic Club of NY, 2006):
•
To the extent that the decline in forward rates can be traced to a
decline in the term premium, . . . the effect is financially stimulative
and argues for greater monetary policy restraint, all else being equal.
•
Specifically, if spending depends on long-term interest rates, special
factors that lower the spread between short-term and long-term
rates will stimulate aggregate demand.
•
Thus, when the term premium declines, a higher short-term rate is
required to obtain the long-term rate and the overall mix of financial
conditions consistent with maximum sustainable employment and
stable prices.
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Why is all this important for central banks?
•
But in a simple linearised New Keynesian model, it is the expected
path of the short-term RIR that determines the extent of
intertemporal substitution and hence current output
•
Long-term interest rates matter only because they embed
expectations of future short-term rates
•
This framework does not allow shifts in TP to affect output: the
recent decline in TP should be ignored when constructing optimal
monetary policy
•
The only important consideration should be the restraining influence
of the rising expected rate component
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Why is all this important for central banks?
•
Given these contradictory practitioner and New Keynesian views
about the macroeconomic implications of changes in the term
premium, we need to know what economic theory more generally
implies about this relationship as well as what the data have to say
→ Build and examine a structural dynamic stochastic general
equilibrium (DSGE) framework that can more completely characterize
the relationship between the term premium and the economy
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Background
Record-low bond yields
In per cent
Ten-year nominal bond yields1
Ten-year real bond yields2
1
The hyperinflation of 1922–23 is excluded for Germany. 2 Prior to 2006, nominal 10-year yields minus average inflation rate during the
next 10 years are used. From 2006 onwards, 10-year index-linked bond yields are used.
Sources: Bloomberg; Global Financial Data; national data; BIS calculations.
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Background (cont)
Ten-year bond yields have followed nominal GDP growth down
In per cent
United States
Japan
Germany
United Kingdom
Sources: OECD, Economic Outlook; Global Financial Data; BIS calculations.
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Background (cont)
 Historically, nominal GDP growth and 10-year bond yields have
lined up reasonably well
 But recently, bond yields stood a few percentage points below
both actual and forecast nominal GDP growth
 What is going on?
• Structural factors may have lowered expected interest rates
and term premia.
• Expected interest rates may have fallen due to downgraded
expectations of long-term real interest rates (global savings
glut, secular stagnation in the core advanced economies)
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What is going on? (cont)
Structural explanations of the fall in bond yields (cont)
• Expected future inflation may have shifted downwards as a
result of persistent low inflation and structural factors (ageing
societies)
• Term premia may have fallen for the foreseeable future due
to financial investors’ structurally higher demand for safe
bonds because of favourable regulatory treatment and
greater demand for collateral
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What is going on? (cont)
Alternative view: temporary factors
• Prolonged low (and even negative) policy rates and forward
guidance have pushed down expected future short-term rates
• Large-scale asset purchases have lowered term premia by
absorbing duration risk, inducing portfolio rebalancing and
reinforcing policy signals
• Large foreign official holdings of core bonds have also weighed
on term premia
• Search for yield and safe haven flows have reduced them further
post-crisis
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Why should all this matter for Poland?
• The only EU country that didn’t have a recession during the
global financial crisis
• Bond markets tiny compared with major advanced economies
• GDP and inflation driven by real, not financial sector
developments (luckily so for Poland)
• Monetary policy totally focused on inflation targeting all along,
no experiments with unconventional tools
• And yet the estimated term premium in Poland is lower than in
the US – how can one explain this?
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