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Interest Rates and Real Activity

Paper Session

Friday, Jan. 5, 2018 8:00 AM - 10:00 AM

Pennsylvania Convention Center, 109-A
Hosted By: American Economic Association
  • Chair: Stephen A. O'Connell, Swarthmore College

Treasury Yield Implied Volatility and Real Activity

Priyank Gandhi
University of Notre Dame
Martijn Cremers
University of Notre Dame
Matthias Fleckenstein
University of Delaware


The implied volatility from Treasury derivatives (Treasury ‘yield implied volatility’) predicts
the level and volatility of macroeconomic activity such as the growth rates of GDP, industrial
production, consumption, and employment. This predictability is robust to the inclusion of
popular forecasting variables used in the current literature. We study one potential explana-
tion for why interest rate uncertainty constitutes a useful forward-looking state variable that
characterizes risks and opportunities in the macroeconomy, namely a bank credit channel.
Consistent with this mechanism, an increase in Treasury yield implied volatility (interest rate
uncertainty) adversely impacts bank deposits, bank credit growth, and banks’ cost of capital,
as well as investments by bank dependent firms. Our study provides novel evidence that
interest rate risk impacts banks not only through levels, but also via uncertainty

Why Have Interest Rates Fallen Far Below the Return on Capital

Magali Marx
Bank of France
Benoit Mojon
Bank of France
François Velde
Federal Reserve Bank of Chicago


Risk-free rates have been falling since the 1980s while the return on capital has not. We
analyze these trends in a calibrated OLG model designed to encompass many of the
"usual suspects" cited in the debate on secular stagnation. Declining labor force and
productivity growth imply a limited decline in real interest rates and deleveraging cannot
account for the joint decline in the risk free rate and increase in the risk premium. If
we allow for a change in the (perceived) risk to productivity growth to fit the data, we
find that the decline in the risk-free rate requires an increase in the borrowing capacity
of the indebted agents in the model, consistent with the increase in the sum of public
and private debt since the crisis but at odds with a deleveraging-based explanation put
forth in Eggertsson and Krugman (2012).

Capital Misallocation and Secular Stagnation

Ander Perez-Orive
Federal Reserve Board
Andrea Caggese
Pompeu Fabra University, CREI, and Barcelona GSE


The widespread emergence of intangible technologies in recent decades may have significantly hurt output growth—even when these technologies replaced considerably less productive tangible technologies—because of low interest rates. After a shift toward intangible capital in production, the corporate sector becomes a net saver because intangible capital has a low collateral value. Firms' ability to purchase intangible capital is impaired by low interest rates because low rates slow down the accumulation of savings and increase the price of capital, worsening capital misallocation. Our model simulations reproduce key trends in the U.S. in the period from 1980 to 2015.

A Shadow Rate New Keynesian Model

Jing Cynthia Wu
University of Chicago
Ji Zhang
Tsinghua University


We propose a New Keynesian model with the shadow rate, which is the federal funds rate during normal times. At the zero lower bound, we establish empirically the negative shadow rate summarizes unconventional monetary policy with its resemblance to private interest rates, the Fed's balance sheet, and Taylor rule. Theoretically, we formalize our shadow rate New Keynesian model with QE and lending facilities. Our model generates the data-consistent result: a negative supply shock is always contractionary. It also salvages the New Keynesian model from the zero lower bound induced structural break.
JEL Classifications
  • E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy