Secular Economic Changes and Bond Yields

What are the economic forces behind the decline in the trend of bond yields?  We build a model with long- and short-run components that:

• connects bond yields to macroeconomic variations
• enables cyclical and secular components
• allows different sources of economic shocks with weights that change over time

We use this model to track the impact of nominal shocks on bond yields and the economy. We define nominal shocks as shocks that influence cyclical fluctuations in output, inflation and interest rates but leave the real output growth and real rate unchanged in the long run. We find that before the anchoring of inflation in the mid-1990s, nominal shocks drive inflation and bond yields down. Afterward, the impacts of nominal shocks on bond yields are much less significant.

We suggest three reasons for this change:

• The sensitivity of the secular inflation to nominal shocks eventually disappears in our sample (i.e., inflation becomes “anchored”).
• The large and persistent impacts of the nominal shocks on the cyclical variations in output, inflation and the short rate become smaller and last for shorter periods later in our sample.
• The response of the term premium to nominal shocks becomes much less persistent over time.

We find that these changes operate essentially simultaneously.