Trend and Uncertainty in the Long-Term Real Interest Rate: Bayesian Exponential Tilting with Survey Data
New estimates of trend inflation and interest rates suggest the economy has not permanently shifted to a low-growth and low-inflation regime.
Economic growth and inflation as well as interest rates have remained low in the U.S. since the Great Recession of 2007-9, creating renewed interest in the secular stagnation hypothesis that tightly links the permanent downward shift in the real interest rate with the predictable decline in economic growth and inflation. To empirically investigate this hypothesis, I set-up and estimate a time-varying parameter vectorautoregression (TVP-VAR) model with stochastic volatility using Bayesian methods to obtain trend estimates for the long-term real interest rate. I estimate trend as the long-run average forecast and simulate its predictive density. The median estimate of the trend long-term real interest rate is mostly in line with the existing literature. However, uncertainty band is generally higher. In addition, uncertainty is not in general symmetric with downside (upside) risk more prominent during certain periods. When model-implied forecasts are tilted to match variances as well as means of forecasts from the survey data, the trend estimates of the long-term nominal interest rate and inflation feature much smaller downside risk than those without tilting or tilting to match means only. Forecasts tilted to match both means and variances are more in line with the finding from the existing literature that the U.S. has experienced the negligible chance of a shift to deflation regime during the recent period. While point estimates of trends from the TVP-VAR model are roughly in line with the secular stagnation hypothesis, the level and time variation of uncertainty in the predictive density cast doubt on the idea that these declines were fairly predictable and permanent.
Download paper, RWP 17-08, July 2017
JEL Classification: C11; E43
- Taeyoung Doh. 2017. "Trend and Uncertainty in the Long-Term Real Interest Rate: Bayesian Exponential Tilting with Survey Data" Federal Reserve Bank of Kansas City, working paper no. 17-08, July. Available at https://doi.org/10.18651/RWP2017-08