Secular Changes in Bond Yields
26 Pages Posted: 10 Jan 2020
Date Written: December 12, 2019
We build a small-scale representation of the economy with secular and cyclical changes that are jointly determined by common structural shocks. Bond yields are influenced by cyclical and secular changes to the inflation and real rate endpoints that we recover from the model, but we impose that expected excess returns of bonds are stationary. Once we account for the effects of secular economic changes, we uncover several facts about the relationship between the short-term rate and long-term yields. We find that inflation and output shocks cause the expectation component of long-term yields to rise but cause the term premium to decline. However, we find that short rate shocks push expectation and term premium in the same direction. Since, in the model, the relative contribution of macro shocks changes over time, unexpected changes to the short rate can have a large impact on the term premium but with a sign that depends on the nature of the structural shocks. When macro shocks are relatively more important, the term premium tends to mute the transmission to long-term yields. By contrast, when short rate shocks are more important, the term premium tends to amplify the transmission to long-term yields.
Keywords: Term Structure, Macro-Finance, Variance Decomposition
JEL Classification: C32, E43, G12
Suggested Citation: Suggested Citation