What Are the Consequences of
Long Spells of Low Interest Rates?

Conference Agenda

Friday, September 7

 

7:30 am

Registration and Breakfast

8:30 am

Welcome and Opening Remarks

Eric S. Rosengren
President and Chief Executive Officer
Federal Reserve Bank of Boston

Remarks and Slides

9:00 am

Reality Check from the Markets: A Panel Discussion

Moderator

Loretta J. Mester
President and Chief Executive Officer
Federal Reserve Bank of Cleveland

Panelists

Roger W. Ferguson, Jr.
President and Chief Executive Officer
TIAA
Jan Hatzius
Chief Economist and Head of Global Economics and Markets Research
Goldman Sachs
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Elizabeth A. Ward
Executive Vice President, Chief Financial Officer, and Chief Actuary
Massachusetts Mutual Life Insurance Company
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10:15 am

Break

Morning Moderator

Joanna Stavins
Senior Economist and Policy Advisor
Federal Reserve Bank of Boston

10:45 am

What Anchors for the Natural Rate of Interest?

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This paper takes a critical look at the conceptual and empirical underpinnings of prevailing explanations of low real (inflation-adjusted) interest rates over long horizons and finds them incomplete. The role of monetary policy, and its interaction with the financial cycle in particular, deserves greater attention. By linking booms and busts, the financial cycle generates important path dependencies that give rise to intertemporal policy tradeoffs. Policy today constrains policy tomorrow. The policy regime is not neutral and can exert a persistent influence on the economy's evolution, including on the real interest rate. This raises serious conceptual and practical questions about the use of the natural interest rate as a monetary policy guidepost. In developing the analysis, the paper also provides a specific critique of the safe asset shortage hypothesis—a hypothesis that has gained considerable popularity in recent years.

Authors

Claudio Borio
Head, Monetary and Economic Department
Bank for International Settlements
Piti Disyatat
Executive Director, Puey Ungphakorn Institute for Economic Research
Bank of Thailand
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Phurichai Rungcharoenkitkul
Senior Economist
Bank for International Settlements

Discussant

Tobias Adrian
Financial Counsellor and Director of the Monetary and Capital Markets Department
International Monetary Fund
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12:00 pm

Luncheon

Afternoon Moderator

José L. Fillat
Senior Economist and Policy Advisor
Federal Reserve Bank of Boston

1:00 pm

How Does Low for Long Impact Credit Risk Premiums?

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The Federal Reserve's experiments in monetary policy related to the Global Financial Crisis lasted longer than any previous easing cycle, giving rise to the question of how does a long-term and low interest rate environment affect the pricing of credit risk. We decompose credit default swap (CDS) rates into expected losses and credit risk premia, and show that the level of and firms' exposure to systemic default risk controls for mis-measuring expected losses and proxies for CDS market liquidity to explain more than 80 percent of the variation in risk premia across firms and over time. We show that in the zero lower bound period, residual risk premia are lower for high-yield debt compared to investment-grade debt—consistent with a reaching-for-yield interpretation. Our findings are also consistent with investors demanding compensation for ambiguity aversion related to the end of the low rate environment, a decrease in the supply of risk capital, and the higher costs of trading credit risky instruments due to regulatory changes.

Authors

Antje Berndt
Research School of Finance, Actuarial Sciences, and Statistics
Australian National University
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Jean Helwege
Professor of Finance, School of Business
University of California, Riverside

Discussant

Robin Greenwood
George Gund Professor of Finance and Banking
Harvard Business School
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2:15 pm

Low Interest Rates and Investor Behavior: A Behavioral Perspective

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We discuss the behavioral perspective on "reaching for yield" in financial markets; that is, investors have a greater appetite for risk taking when interest rates are low. We summarize evidence on the intrinsic individual-level reaching-for-yield motive, obtained from randomized experiments and from observational data. The findings hold among diverse populations, and the effect becomes increasingly pronounced as interest rates decrease below historical norms. We then lay out mechanisms that help to understand such behavior, including reference dependence and salience. The behavioral perspective of reaching for yield points to one venue for the "risk-taking channel" of monetary policy, which highlights the importance of savers' preferences and psychology.

Authors

Chen Lian
Economics PhD Candidate
Massachusetts Institute of Technology
Yueran Ma
Booth School of Business
University of Chicago

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Discussant

Malcolm Baker
Robert G. Kirby Professor of Business Administration
Harvard Business School
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3:30 pm

Break

4:00 pm

International Perspectives on the Policy Implications Posed by a Prolonged Period of Low Interest Rates: A Panel Discussion

Moderator

Benjamin M. Friedman
William Joseph Maier Professor of Political Economy
Harvard University

Panelists

Kristin J. Forbes
Jerome and Dorothy Lemelson Professor of Management and Global Economics
Massachusetts Institute of Technology
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Philipp Hartmann
Deputy Director General, Research Department
European Central Bank
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Takatoshi Ito
School of International and Public Affairs
Columbia University
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5:30 pm

Reception

Saturday, September 8

7:30 am

Registration and Breakfast

Morning Moderator

Jeffrey C. Fuhrer
Executive Vice President and Senior Policy Advisor
Federal Reserve Bank of Boston

8:30 am

Keynote Address

Lawrence H. Summers
Charles W. Eliot University Professor and President Emeritus
Harvard University
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9:00 am

Looking for Alternatives: Pension Investments around the World, 2008 to 2017

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Using hitherto-unexplored data, this paper provides a first look into pension funds' allocations to alternative asset classes around the world. On average, in the ten years following the financial crisis, allocations to private equity and real estate nearly doubled, representing about 20 percent of assets under management in 2017 for pensions in many of the largest economies. Our sample indicates a $1.8 trillion shift to alternatives (Alts) between 2008 and 2017. This phenomenon equally affected public and private pension funds, as well as funds of all sizes. This shift does not appear to be a consequence of mechanical factors such as an increase in drawn capital or expected returns, but rather reflects a proactive portfolio allocation response to perceived investment opportunities. The extent of the shift to Alts is more pronounced for nations with lower long-term interest rate environments.

Authors

Victoria Ivashina
Lovett-Learned Chaired Professor of Finance
Harvard Business School
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Josh Lerner
Jacob H. Schiff Professor of Investment Banking
Harvard Business School

Discussant

Gabriel Chodorow-Reich
Assistant Professor of Economics
Harvard University
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10:15 am

Break

10:45 am

Some Unpleasant Stabilization Arithmetic

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Before the Great Recession, traditional countercyclical monetary policy, lowering short-term interest rates as the economy weakens, was viewed as the primary tool for addressing economic downturns. However, after the experience of hitting the effective lower bound (ELB) for an extended period of time, we became much more aware of the possible limitations of relying too heavily on traditional countercyclical monetary policy. The challenges to effective countercyclical monetary policy presented by the possibility, in fact the probability, of returning to the ELB in future recessions have highlighted the potential importance of nonmonetary policy tools, such as federal fiscal policy, state and local fiscal policy, and even bank regulatory policy, as necessary sources of countercyclical stabilization policy. However, to implement such policies effectively, policymakers must be both willing and able to use them, which requires both the desire to use the available countercyclical tools and policy buffers of a size sufficient for them to be useful. Thus, a current concern is the extent to which the United States has sufficient policy buffers to offset a large adverse shock.

This paper highlights that limitations in using short-term interest rates to combat economic downturns is likely to be a recurring problem, given the increased likelihood of the federal funds rate hitting the ELB. We explicitly consider monetary and nonmonetary policy buffers to gauge how resilient the economy is likely to be in the next recession. We focus on individual US states, which allows us to evaluate how critical the various policy buffers are at the individual state level, while recognizing differences in the extent to which states will be impacted, both by countercyclical policies and by limitations imposed by insufficient policy buffers, given the differences in such factors as states’ sensitivities to countercyclical monetary and federal fiscal policies.

From a policy perspective, more attention should be given to establishing appropriate policy buffers to mitigate future shocks. For state and the federal governments, we highlight the potential downside of using up financial capacity during this recovery. For bank regulation, we highlight the importance of maintaining a well-capitalized and resilient banking system. For monetary policy, considering how best to respond to the increased likelihood of hitting the ELB in the future—and either building a larger monetary policy buffer or being more willing to aggressively use nontraditional tools—will be essential.

Authors

Joe Peek
Vice President and Economist
Federal Reserve Bank of Boston
Eric S. Rosengren
President and Chief Executive Officer
Federal Reserve Bank of Boston
Geoffrey M.B. Tootell
Executive Vice President and Director of Research
Federal Reserve Bank of Boston

Discussant

Olivier Blanchard
C. Fred Bergsten Senior Fellow
Peterson Institute for International Economics
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12:00 pm

Keynote Address

Laurence M. Ball
Professor of Economics
Johns Hopkins University
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12:30 pm

Luncheon

1:30 pm

Adjournment