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Equilibrium Interest Rate and the Yield Curve in a Low Interest Rate Environment

July 2007
Hibiki Ichiue*1
Yoichi Ueno*2

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Equilibrium nominal interest rates are useful indicators for both monetary policy authorities and market players. However, there are few studies which estimate Japan's equilibrium rate because of its persistent low interest rate. We overcome this challenge by using survey forecasts of interest rates and macroeconomic variables to estimate a two-factor yield curve model, which takes the bound of zero interest into account. We found that: 1) the equilibrium rate is roughly approximated with the long-run expected nominal output growth rate; 2) the Bank of Japan's commitments successfully lowered yields even at zero interest; and 3) the term premium of 10-year yield has had a downtrend since 2004.

JEL classification: E43, E44, E52, G12

Keywords: Equilibrium interest rate, Black's model of interest rates as options, Monetary policy, Macro-finance, Survey data

We would like to thank Naohiko Baba, Ippei Fujiwara, Yoshifumi Hisada, Keiji Kono, Mototsugu Shintani, Toshinao Yoshiba, and the staff at the Bank of Japan for their helpful comments. The views expressed here are ours alone, and do not necessarily reflect those of the Bank of Japan.

  • *1 Financial Markets Department (currently Research and Statistic Department)
  • *2 Financial Markets Department (currently Personnel and Corporate Affairs Department)


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