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Jel Classification:E43 

The equilibrium real policy rate through the lens of standard growth models

The long-run equilibrium real policy rate is a key concept in monetary economics and an important input into monetary policy decision-making. It has gained particular prominence lately as the Federal Reserve continues to normalize monetary policy. In this study, we assess the evolution, current level, and prospective values of this equilibrium rate within the framework of standard growth models. Our analysis considers as a baseline the single-sector Solow model, but it places more emphasis on the multi-sector neoclassical growth model, which better fits the data over the past three decades. ...
Current Policy Perspectives , Paper 17-6

The liquidity effect of the Federal Reserve’s balance sheet reduction on short-term interest rates

I examine the impact of the Federal Reserve?s balance sheet reduction on short-term interest rates emanating from the declining supply of reserve balances. Using an exogenous shift in the supply of reserves, I estimate that by January 2019, when the Fed will have reduced its portfolio by $500 billion, the overnight repurchase agreement (repo) spread (relative to the lower bound of the federal funds target range) will be 10 basis points higher and the fed funds spread will be 2 basis points higher than in October 2017, all else being equal. I also find that a declining supply of reserve ...
Current Policy Perspectives , Paper 18-1

Predicting Recessions Using the Yield Curve: The Role of the Stance of Monetary Policy

The yield curve is often viewed as a leading indicator of recessions. While the yield curve’s predictive power is not without controversy, its ability to anticipate economic downturns endures across specifications and time periods. This note examines the predictive power of the yield curve after accounting for the current stance of monetary policy—a relevant issue given that monetary policy was unusually accommodative during the most recent yield curve inversion, in the third quarter of 2019. The results show that a yield curve inversion likely overstates the probability of a recession ...
Current Policy Perspectives

The Great Leverage 2.0? A Tale of Different Indicators of Corporate Leverage

Many policymakers have expressed concerns about the rise in nonfinancial corporate leverage and the risks this poses to financial stability, since (1) high leverage raises the odds of firms becoming a source of adverse shocks, and (2) high leverage amplifies the role of firms in propagating other adverse shocks. This policy brief examines alternative indicators of leverage, focusing especially on the somewhat disparate signals they send regarding the current state of indebtedness of nonfinancial corporate businesses. Even though the aggregate nonfinancial corporate debt-to-income ratio is at ...
Current Policy Perspectives

Working Paper
Reach for Yield by U.S. Public Pension Funds

This paper studies whether U.S. public pension funds reach for yield by taking more investment risk in a low interest rate environment. To study funds? risk-taking behavior, we first present a simple theoretical model relating risk-taking to the level of risk-free rates, to their underfunding, and to the fiscal condition of their state sponsors. The theory identifies two distinct channels through which interest rates and other factors may affect risk-taking: by altering plans? funding ratios, and by changing risk premia. The theory also shows the effect of state finances on funds? risk-taking ...
Supervisory Research and Analysis Working Papers , Paper RPA 19-2

Working Paper
Bad Sovereign or Bad Balance Sheets? Euro Interbank Market Fragmentation and Monetary Policy, 2011-2015

We measure the relative role of sovereign-dependence risk and balance sheet (credit) risk in euro area interbank market fragmentation from 2011 to 2015. We combine bank-to-bank loan data with detailed supervisory information on banks? cross-border and cross-sector exposures. We study the impact of the credit risk on banks? balance sheets on their access to, and the price paid for, interbank liquidity, controlling for sovereign-dependence risk and lenders? liquidity shocks. We find that (i) high non-performing loan ratios on the GIIPS portfolio hinder banks? access to the interbank market ...
Supervisory Research and Analysis Working Papers , Paper RPA 18-3

Safety, liquidity, and the natural rate of interest

Why are interest rates so low in the Unites States? We find that they are low primarily because the premium for safety and liquidity has increased since the late 1990s, and to a lesser extent because economic growth has slowed. We reach this conclusion using two complementary perspectives: a flexible time-series model of trends in Treasury and corporate yields, inflation, and long-term survey expectations, and a medium-scale dynamic stochastic general equilibrium (DSGE) model. We discuss the implications of this finding for the natural rate of interest.
Staff Reports , Paper 812

Interest rate conundrums in the twenty-first century

Long-term nominal interest rates are known to be highly sensitive to high-frequency (daily or monthly) movements in short-term rates. We find that, since 2000, this high-frequency sensitivity has grown even stronger in U.S. data. By contrast, the association between low-frequency changes (at six- or twelve-month horizons) in short- and long-term rates, which was also strong before 2000, has weakened substantially. We show that this puzzling post-2000 combination of high-frequency ?excess sensitivity? and low-frequency ?decoupling? of short- and long-term rates arises because increases in ...
Staff Reports , Paper 810

Payment size, negative equity, and mortgage default

Surprisingly little is known about the importance of mortgage payment size for default, as efforts to measure the treatment effect of rate increases or loan modifications are confounded by borrower selection. We study a sample of hybrid adjustable-rate mortgages that have experienced substantial rate reductions over the past years and are largely immune to these selection concerns. We find that payment size has an economically large effect on repayment behavior; for instance, cutting the required payment in half reduces the delinquency hazard by about 55 percent. Importantly, the link between ...
Staff Reports , Paper 582

The Microstructure of China's Government Bond Market

Although China now has one of the largest government bond markets in the world, the market has received relatively little attention and analysis. We describe the history and structure of the market and assess its functioning. We find that trading in individual bonds was historically sparse but has increased markedly in recent years. We find also that certain announcements of macroeconomic news, such as China?s producer price index (PPI) and manufacturing purchasing managers? index (PMI), have significant effects on yields, even when such yields are measured at a daily level. Despite the ...
Staff Reports , Paper 622


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