What's in store for r*?

It is amazing how things we once thought impossible, or at least extremely improbable, can become commonplace. Ten-year government bond yields in most of Europe and Japan are at or below zero. And, for U.S. Treasurys, the yield has been below 1 percent since March.

A confluence of factors has come together to deliver these incredibly low interest rates. Most importantly, inflation is far lower and much more stable than it was 30 years ago. Second, monetary policy remains extremely accommodative, with policy rates stuck around zero (or below!) for the past decade in Europe and Japan, and only temporarily higher in the United States. Third, the equilibrium (or natural) real interest rate (r*)—the rate consistent in the longer run with stable inflation and full employment—has fallen by roughly 2 percentage points since 2008 and is now only 0.5% or lower.

How long will this go on? What’s in store for r*? Focusing on the United States, in this post we discuss the large post-2007 decline in r* that followed a gradual downward trend in prior decades. After considering various possible explanations, we focus on the change in U.S. saving behavior. Around 2008, there was an abrupt increase in household savings relative to wealth and income. Combined with increased foreign demand for U.S. assets, this appears to be a key culprit behind the recent fall in r*.

We doubt that this will change anytime soon….

Has the U.S. Distribution of Wealth Worsened?

Wealth inequality in the United States is obvious to everyone. The Federal Reserve’s triennial Survey of Consumer Finance (SCF) documents the glaring and persistent divide between rich and poor, confirming that ownership of financial and real assets in the United States has been highly concentrated for decades (see our earlier post). The most recent 2016 estimates suggest that the top 10% of the wealth distribution own nearly three-quarters of all marketable assets, with the top 1% owning more than half of that. And, Saez and Zucman (SZ) estimate that the U.S. distribution has been getting worse, with the top 1% share of marketable wealth rising by more than 10 full percentage points since 1989.

But, as Catherine, Miller and Sarin (CMS) recently highlight, adding in the present discounted value of Social Security benefits (net of taxes) to construct a more comprehensive measure of wealth alters these patterns. First, according to CMS’s estimates, the share of marketable wealth in total wealth has plunged by more than 18 percentage points since 1989. Second, over the past three decades, the top 1% share of total wealth has risen only modestly, while the share owned by the top 10% has declined somewhat.

In this post, we highlight the CMS results, and decompose their changes in total wealth shares into two parts: the changes in marketable and Social Security wealth shares accruing to each group, and the aggregate decline over time of marketable wealth as a share of total wealth. We show that the latter dominates the overall trend in this more comprehensive measure of inequality….

COVID-19: What can monetary policy do?

Two weeks prior to their regularly scheduled mid-March meeting, the members of the Federal Open Market Committee (FOMC) voted unanimously to cut their target policy rate by 50 basis points to the 1 to 1¼ percent range. Policymakers attributed their exceptional decision to the “evolving risks” posed by the coronavirus. This move was the first inter-meeting policy rate shift, and the largest cut, since late 2008, at the depth of the financial crisis. Moreover, this time the move came against the background of a strong economy. Nevertheless, based on futures prices, market participants anticipate a further 75-basis-point cut in the target federal funds rate this month!

The coronavirus has thrust us into uncharted territory. Do central bankers really have any tools to guide us back to safer ground?

In the remainder of this post, we discuss the importance for policymakers of distinguishing between shocks to aggregate supply and demand. Importantly, while monetary policy can combat demand shocks, it can do nothing to cushion the impact of reductions in supply without sacrificing the commitment to price stability. The coronavirus shock involves some as-yet-unknown mix of these two very different types of shocks. Yet, given the limited amount of conventional policy space, and the decline of long-term inflation expectations, there is a good case for the FOMC to act rapidly and aggressively….

Commentary

Money, Banking, and Financial Markets