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2023 Oct/31
Reduced Interest Rate Sensitivity in the US Economy and its Implications
Issue Papers 23-22
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- Research Topic Macrofinance
- Page 21
- Summary
- Amid a surge in interest rates from the second half of 2022, major forecasting institutions initially presented a grim outlook for the US economic growth rate for 2023. However, as the US economy showed a more resilient growth trend than expected, these growth forecasts have been gradually revised upward. Previous studies have highlighted that structural economic changes, including financial innovation, regulatory relaxation, improvements in the monetary policy response framework, and globalization have contributed to the insensitivity of the US economy to interest rate changes. On the other hand, this article draws attention to a significant weakening of the impact of interest rates among monetary policy transmission channels during the current rate hike.
In this context, this article examines factors behind the change in long-term US Treasury yields during the recent rate hike period (March 2022 to July 2023) and decomposes these factors into monetary policy forecasts and the term premium for long-term Treasury bond holdings. Unlike previous rate hike periods, the rise in Treasury yields is solely attributed to monetary policy expectations, while the term premium has remained almost unchanged. Utilizing a dynamic stochastic general equilibrium (DSGE) model, this article analyzes the cause of the unusually low level of term premiums. It has been estimated to decline by nearly 100 basis points as of the end of 2022, primarily driven by large-scale Treasury bond holdings resulting from the US Fed’s quantitative easing. It is also noteworthy that as the mortgage, which comprises two-thirds of US household debt, primarily involves long-term fixed rates, the debt service burden of US households has remained at pre-Covid 19 levels, despite a sharp increase in the benchmark rate. In addition, the expansion of the aging Baby Boom generation with lower debt exposure has contributed to weakening the interest rate path.
As the correlation between the US real economy and interest rates is reduced, the uncertainty in estimating the neutral real interest rate, a reference rate for monetary policy, has increased. Accordingly, this inevitably necessitates improvised monetary policies for an extended period and makes it challenging to determine the appropriate level of tightening, possibly heightening uncertainty regarding the future growth trajectory. It should also be noted that the long-term US Treasury bond yields are expected to be greatly swayed by the term premium, rather than expectations for monetary policy. If a steep rise in term premium, as observed in September 2023, triggers Treasury yields hikes, it could lead to simultaneous increases in Korean government bond yields and intensify exchange rate volatility.