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A Simple
Framework Offers
Insight into the
Neutral Rate
Conundrum.
What is the neutral level of interest rates? Arguably, few other questions
may be so simply posed by an investor but prove so difficult to answer
convincingly. Determining the interest rate that should be consistent
with an economy operating at near-full capacity with close-to-target
inflation is of profound importance.
Wesley Phoa
Portfolio Manager
Los Angeles Office
20 years of experience (as of 12/31/13)
15 years of experience at Capital Group
Not only can knowledge of the neutral rate offer a guide to the likely
path of monetary policy, its a key driver of future bond returns, a
determinant of future liability returns (via discount rates) and even
influences expected equity returns.
Here, we develop an intuitive economic framework, identify the specific
drivers of the neutral interest rate and long-run U.S. Treasury yields,
and explore whether recent structural developments have prompted
fundamental changes.
Market Commentary
Exploring Structural Change in
Interest Rates
July 2014
Key takeaways
There is good reason to believe
that the neutral levels of both
short-term interest rates and
Treasury yields are lower than
they were a decade ago though
not as low as some commentators
have recently suggested.
Since the financial crisis, estimates of neutral rates have a
wider (but still bounded) range of
uncertainty.
Once the economy has reached
full employment, maintaining
a nominal federal funds target
rate of only 2% could be highly
inflationary.
9
7
Market-implied estimate
(TIPS; medium- /long-run)
(econometric; short-run)
1
1961
1965
1969
1973
1977
1981
1985
1989
1993
1997
2001
2005
2009
2013
Source: Capital Group calculations; Laubach, Thomas, and John Williams. 2003. Measuring
the Natural Rate of Interest. The Review of Economics and Statistics 85(4) (November), pp.
10631070. Weise, Charles and Barbera, Robert, Minsky Meets Wicksell: Using the Wicksellian
Model to Understand the Twenty-First Century Business Cycle, in Macroeconomic Theory and
Macroeconomic Pedagogy (Giuseppe Fontana and Mark Setterfield, editors), Basingstoke and
New York, Palgrave Macmillan, 2009.
Market Commentary
Exploring Structural Change in
Interest Rates
July 2014
Market Commentary
Exploring Structural Change in
Interest Rates
July 2014
Market Commentary
Exploring Structural Change in
Interest Rates
July 2014
Market Commentary
Exploring Structural Change in
Interest Rates
July 2014
The statements expressed herein are informed opinions, are as of the date noted, and are subject to change at any time based on market or other
conditions. They reflect the view of an individual and may not reflect the views of others across the organization. This information is intended merely
to highlight issues and not to be comprehensive or to provide advice. Permission is given for personal use only. Any reproduction, modification,
distribution, transmission or republication of the information, in part or in full, is prohibited.
For financial professionals only. Not for use with the public.
Lit. No. ITGEFL-034-0714P Printed in USA CGD/CG/9866-S44779 2014 The Capital Group Companies, Inc.