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Working Paper
Resolving the spanning puzzle in macro-finance term structure models
Previous macro-finance term structure models (MTSMs) imply that macroeconomic state variables are spanned by (i.e., perfectly correlated with) model-implied bond yields. However, this theoretical implication appears inconsistent with regressions showing that much macroeconomic variation is unspanned and that the unspanned variation helps forecast excess bond returns and future macroeconomic fluctuations. We resolve this contradiction?or ?spanning puzzle??by reconciling spanned MTSMs with the regression evidence, thus salvaging the previous macro-finance literature. Furthermore, we ...
Working Paper
High-Frequency Estimates of the Natural Real Rate and Inflation Expectations
We propose a new method of estimating the natural real rate and long-horizon inflation expectations, using nonlinear regressions of survey-based measures of short-term nominal interest rates and inflation expectations on U.S. Treasury yields. We find that the natural real rate was relatively stable during the 1990s and early 2000s, but declined steadily after the global financial crisis, before dropping more sharply to around 0 percent during the recent COVID-19 pandemic. Long-horizon inflation expectations declined steadily during the 1990s and have since been relatively stable at close to 2 ...
Discussion Paper
Are Financial Markets Good Predictors of R‑Star?
Recently, there has been renewed attention on the natural rate of interest—often referred to as “r-star”—and whether it has risen from the historically low levels that prevailed before the COVID-19 pandemic. The natural interest rate is the real (inflation-adjusted) interest rate expected to prevail when supply and demand in the economy are in balance and inflation is stable. Some commentators claim that the prior decline in r‑star has reversed, pointing to the recent rise in future real interest rates implied by the bond market. But before declaring the death of this “low ...