The Drivers of r*: Accounting for Treasuries' Convenience Yield

34 Pages Posted: 15 May 2024

See all articles by Balint Szoke

Balint Szoke

Board of Governors of the Federal Reserve System

Francisco Vazquez-Grande

Board of Governors of the Federal Reserve System

Inês Xavier

Board of Governors of the Federal Reserve System

Date Written: March 31, 2024

Abstract

Since the Great Financial Crisis (GFC), the decline in the estimated natural rate of interest (r*) has outpaced the fall in expected potential output growth, leaving most of the decline unexplained. A growing literature highlights the importance of the premium commanded by liquid assets--often referred to as convenience yield--for the determination of the natural rate of interest and the transmission of monetary policy. This paper estimates r* using a stylized New-Keynesian model that explicitly accounts for the convenience yield on US Treasury securities. We present evidence that two slow-moving variables, the permanent component of potential output growth and the permanent component of the convenience yield on US Treasuries, almost fully account for the level of r*. We show that a rise in the convenience yield has contributed to the decline in r* since the GFC, and that accounting for the dynamics of the convenience yield increases the precision of the r* estimates.

Keywords: natural rate of interest, monetary policy, convenience yield

JEL Classification: C32, E43, E52, O40

Suggested Citation

Szoke, Balint and Vazquez-Grande, Francisco and Xavier, Inês, The Drivers of r*: Accounting for Treasuries' Convenience Yield (March 31, 2024). Available at SSRN: https://ssrn.com/abstract=4828053 or http://dx.doi.org/10.2139/ssrn.4828053

Balint Szoke

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Francisco Vazquez-Grande (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States
202-973-7488 (Phone)

Inês Xavier

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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