Regional President Speech

The Global Challenge of Very Low R-Star

Figures presented at the Bank of Korea International Conference

Seoul, Republic of Korea

By John C. Williams, President and CEO, Federal Reserve Bank of San Francisco For delivery June 1, 2017

These figures were presented in conjunction with a keynote address by President Williams at a conference hosted by the Bank of Korea.

The Decline in R* in the U.S.

Range of existing r-star estimates Percent

-1 1986 1991 1996 2001 2006 2011 2016 Estimates from Laubach and Willams (2003), Kiley (2076), Lubik and Matthes (2016), Johanssen and Mertens (2016), Holston, Laubach, and Williams (2016), Crump, Eusepi, and Moench (2016), and Christensen and Rudebusch (2017) [estimates begin 1998q2], and

Del Negro et al (2017).

International Evidence

Estimates of R* and Trend Growth

GDP-weighted average USA, Canada, Euro Area, and UK lager

Trend growth (g)

Natural rate (r*)

1986 1991 1996 2001 2006 2011 2016

Estimates from Holston, Laubach, & Williams (2016). Weights are GDP at purchasing power parity, OECD estimates. Prior to 1995, Euro Area weights are summed weights of the 11 orginal Euro Area countries,

Why Has R* Declined?

¢ Canonical Euler equation for consumption: ‘ af rr =(—]: gs t+e— F ¥ : natural real interest rate (on safe asset)

: growth rate of consumption : discount rate (including mortality risk)

: safe asset spread (convenience yield)

U.S. Productivity Growth Slowdown

United States TFP and labor productivity growth

10-year averages, quarterly percent change at annual rate Percent

= Total business sector labor productivity @ Utilization-adjusted TFP

1957-1966 1967-1976 1977-1986 1987-1996 1997-2006 2007-2016 Source: Femald (2012)

OECD Productivity Growth Slowdown

OECD TFP and labor productivity growth

Average of OECD countries, annual percent changes Percent 2.0

= Labor productivity a TFP

1:5

0.5

1990-2004 2005-2016

Source: Conference Board Total Economy Database

Demographics

Projections for life expectancy and population growth OECD average

Years

100

95

90

85

80

15

70

65

60

59

50

1950

Life expectancy

1970 1990

Percent

2 Projections

Population growth (right axis)

2010 2030 2050 2070 2090

Source: United Nations World Population Prospects: The 2015 Revision

Liquidity Spreads

Corporate bond spreads Percentage points 9

——Bloomberg industrials A 20-year

—Bloomberg industrials BBB 20-year —Gilchrist and ZakrajSek (2012) spread

1995 1998 2001 2004 2007 2010 2013 2016

U.S. Expected Returns Have Fallen with R*

SPF forecasts of 10-year real returns Percent

S oD

Change Bonds 1998-2017

Equities -2.7 Bonds -1./ T-Bills -2.2

1992 1997 2002 2007 2012 2017 Bond retums, stock returns, and 3-month T-bill retums are deflated with SPF long-run CPI inflation forecast.

Why Has R®* Declined?

1998 — 2016

AR*

AG Aother

United States

Laubach-Williams -2.4 Holston-Laubach-Williams | -2.6 Del Negro et al. DSGE model | -2.4 Global (CA, EA, US, Uk) | Holston-Laubach-W illiams -2.2

-1.3 -1.1 -1.8 -0.7 -1.0 -1.4

-1.4 -0.8

Policy Implications

Lower bound will bind frequently in future, hampering monetary policy effectiveness.

“Unconventional policies” will become the norm, with potential adverse financial stability implications.

Need to reassess policy frameworks, to be resilient to low r-star world, while delivering on price stability, anchored inflation expectations, and macroeconomic goals.