Accounting for Low Long-Term Interest Rates: Evidence from Canada

Author(s): Jens H. E. Christensen, Glenn D. Rudebusch, and Patrick J. Shultz

In recent decades, long-term interest rates around the world have fallen to historic lows. We examine the source of this decline using a dynamic term structure model of Canadian nominal and real yields with adjustments for term, liquidity, and inflation risk premiums. Canada provides a novel perspective on this issue because of its established indexed debt market, negligible distortions from monetary quantitative easing or the zero lower bound, and absence of sovereign credit risk. We find that since 2000, the steady-state real interest rate has fallen by more than 2 percentage points, long-term inflation expectations have edged down, and real bond and inflation risk premiums have varied over time but shown little longer-run trend. Therefore, the drop in the equilibrium real rate appears largely to account for the lower new normal in interest rates.

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Article Citation

Christensen, Jens H. E, Glenn D. Rudebusch, and Patrick J. Shultz. 2021. "Accounting for Low Long-Term Interest Rates: Evidence from Canada," Federal Reserve Bank of San Francisco Working Paper 2020-35. Available at https://doi.org/10.24148/wp2020-35