The Natural Rate Puzzle: Global Macro Trends and the Market-Implied R

41 Pages Posted: 14 Jan 2020

See all articles by Josh Davis

Josh Davis

Pacific Investment Management Company (PIMCO)

Cristian Fuenzalida

Pacific Investment Management Company (PIMCO)

Alan M. Taylor

University of California, Davis - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: December 2019

Abstract

Benchmark finance models deliver estimates of bond risk premia based on components of Treasury bond yields. Benchmark macroeconomic models deliver estimates of the natural rate of interest based on growth, inflation, and other macro factors. But estimates of the natural rate implied by the former are wildly inconsistent with those of the latter; and estimates of risk premia implied by the latter are wildly inconsistent with those of the former. This is the natural rate puzzle, and we show that it applies not only in the United States but also across several advanced economies. A unified model should not fail such consistency tests. We estimate a unified macro-finance model with long-run trend factors which delivers paths for a market-implied natural rate r* consistent with inflation expectations π* and bond risk premia. These paths are plausible and our factors improve the explanatory power of yield and return regressions. Trading strategies based on signals incorporating both r* and π* trends outperform both yield- only strategies like level and slope and strategies which only add trend inflation. The estimates from our unified model satisfy consistency and deliver a resolution to the puzzle. They show that most of the variation in yields has come from shifts in r* and π*, not from bond risk premia. Our market-implied natural rate differs from consensus estimates, and is typically lower, intensifying concerns about secular stagnation and proximity to the effective lower-bound on monetary policy in advanced economies.

Keywords: affine models, Bond risk premia, Inflation expectations, Natural rate of interest, term structure

JEL Classification: C13, C32, E43, E44, E47, G12

Suggested Citation

Davis, Josh and Fuenzalida, Cristian and Taylor, Alan M., The Natural Rate Puzzle: Global Macro Trends and the Market-Implied R (December 2019). CEPR Discussion Paper No. DP14201. Available at SSRN: https://ssrn.com/abstract=3518540

Josh Davis (Contact Author)

Pacific Investment Management Company (PIMCO) ( email )

United States

Cristian Fuenzalida

Pacific Investment Management Company (PIMCO) ( email )

United States

Alan M. Taylor

University of California, Davis - Department of Economics ( email )

One Shields Drive
Davis, CA 95616-8578
United States
530-752-1572 (Phone)
530-752-9382 (Fax)

HOME PAGE: http://www.econ.ucdavis.edu/faculty/amtaylor/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

HOME PAGE: http://nber.org

Centre for Economic Policy Research (CEPR)

London
United Kingdom

HOME PAGE: http://cepr.org

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
1
Abstract Views
129
PlumX Metrics