The Drivers of r*: Accounting for Treasuries' Convenience Yield
34 Pages Posted: 15 May 2024
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: Suggested Citation