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Friday, March 01, 2013

Bernanke: How are long-term rates likely to evolve over coming years?

by Calculated Risk on 3/01/2013 10:00:00 PM

From Fed Chairman Ben Bernanke: Long-Term Interest Rates. Excerpts:

[W]hy are long-term interest rates currently so low? To help answer this question, it is useful to decompose longer-term yields into three components: one reflecting expected inflation over the term of the security; another capturing the expected path of short-term real, or inflation-adjusted, interest rates; and a residual component known as the term premium. Of course, none of these three components is observed directly, but there are standard ways of estimating them. ...

[H]ow are long-term rates likely to evolve over coming years? It is worth pausing to note that, not that long ago, central bankers would have carefully avoided this topic. However, it is now a bedrock principle of central banking that transparency about the likely path of policy, in general, and interest rates, in particular, can increase the effectiveness of policy. In the present context, I would add that transparency may mitigate risks emanating from unexpected rate movements. Thus, let me turn to prospects for long-term rates, starting with the expected path of rates and then turning to deviations from the expected path that may arise.

If, as the FOMC anticipates, the economic recovery continues at a moderate pace, with unemployment slowly declining and inflation expectations remaining near 2 percent, then long-term interest rates would be expected to rise gradually toward more normal levels over the next several years.