Factors Behind Low Long-Term Interest Rates

Abstract

Long-term bond yields have been low in recent years both in nominal and real terms, and - especially in the United States - they have reacted differently to shifts in monetary and fiscal stances relative to previous cycles. This article examines various possible explanations for this behaviour, such as the effects of changes in monetary policy frameworks on inflation and interest rate expectations; developments in ex ante saving-investment balances, and shifts in investors' portfolio preferences (including official reserve accumulation, "petro-dollar" recycling and pension fund demand for longer maturities). The paper finds that it is unlikely that any individual explanation can account for the level and profile of bond yields in recent years, but that an important element has been a compression in term premia, together with shifts in expected short rates. Even though bond yields have started to rise in the early part of 2006, they are unlikely to go back to the levels that prevailed in the 1980s or the early 1990s, as several of the factors that drove them lower are set to persist.

Keywords: Interest rates, bond yields, term premia, risk premia, neutral rate, inflation expectations, monetary policy, credibility, saving-investment balance, capital flows, current account, pension funds, portfolio preferences, financial markets, bond spreads, reserve accumulation, petro-dollars

JEL Classification: E43, F2, G11, G15