Macroeconomic determinants of long-term government yields : a study of American and Norwegian yields using an ECM approach

Abstract

This thesis examines the macroeconomic determinants of 10-year government bond yields in Norway and the US. We use Johansen cointegration testing and a VECM framework to identify long-run relationships between non-stationary variables. These relationships are further used in a more flexible ECM framework. We find that US rates prior to 2007 had a stable long-run relationship with the US policy rate, 5-year inflation expectations and the current account. Furthermore, we find short-run effects from the policy rate, inflation expectations, VIX (expected volatility in financial markets) and PMI (business cycles), as well as some evidence of an effect of government debt. We find that Norwegian rates over the entire period have a stable long-run relationship with the German 10-year rate and the Norwegian policy rate. We find short-run effects in the pre- 2007 period for the policy rate, German 10-year rate, and the VIX index. We find large changes in the post-2007 period for both countries. Neither rate react to any significant degree to deviations from long-run relationships, and the US long-run relationship breaks completely down. For both countries, most of the estimated short-run effects weaken, or disappear. In this period, the effect of government debt supply is clearer and we also find effects from increases in central bank reserves indicating that QE has had a large impact on long-term rates. In Norway, we only find a significant short-run effect from the German 10-year rate. Overall, we find that the period since 2007 represent a large change in determination of longterm rates compared to the 16 years prior to that period. Even though there have been large changes, our models are still able to predict movements in the rates in recent years relatively well, with some exceptions which are discussed.