Working Paper

A Post-Pandemic New Normal for Interest Rates in Emerging Bond Markets? Evidence from Chile

Abstract: Before the COVID-19 pandemic, researchers intensely debated the extent of the decline in the so-called equilibrium or natural rate of interest. Given the recent sharp increase in interest rates, we revisit this question in an emerging bond market context and offer a Chilean perspective using a dynamic term structure finance model estimated directly on the prices of individual Chilean inflation-indexed bonds with adjustments for bond-specific liquidity risk and real term premia. Beyond documenting the existence of large and time-varying liquidity risk premia in the bond prices, we estimate that the equilibrium real rate in Chile fell about 2 and a half percentage points in the 2003-2022 period and has remained low since then with model projections only suggesting a gradual reversal in coming years. Instead, recent increases in real interest rates in Chile are driven by spikes in the liquidity and term premia of inflation-indexed bond prices.

JEL Classification: C32; E43; E52; G12;

https://doi.org/10.24148/wp2024-04

Bibliographic Information

Provider: Federal Reserve Bank of San Francisco

Part of Series: Working Paper Series

Publication Date: 2024-08-12

Number: 2024-04

Note: Original publication date: 2024-02-21.