Working Paper: NBER ID: w25282
Authors: Emmanuel Farhi; Francois Gourio
Abstract: Real risk-free interest rates have trended down over the past 30 years. Puzzlingly in light of this decline, (1) the return on private capital has remained stable or even increased, creating an increasing wedge with safe interest rates; (2) stock market valuation ratios have increased only moderately; (3) investment has been lackluster. We use a simple extension of the neoclassical growth model to diagnose the nexus of forces that jointly accounts for these developments. We find that rising market power, rising unmeasured intangibles, and rising risk premia, play a crucial role, over and above the traditional culprits of increasing savings supply and technological growth slowdown.
Keywords: equity premium; risk-free rate; investment profitability; valuation ratios; labor share; competition; markups; safe assets
JEL Codes: E0
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| rising market power (D43) | decline in real risk-free interest rates (E43) |
| increasing macroeconomic risk (E49) | decline in real risk-free interest rates (E43) |
| decline in real risk-free interest rates (E43) | widening spread between return on private capital and safe interest rates (E25) |
| rising market power (D43) | lower labor share (E25) |
| increasing risk premia (G19) | lower prices of risky assets (G19) |
| rising spread between return on capital and risk-free rate (G17) | driven by rising market power (D49) |
| rising spread between return on capital and risk-free rate (G17) | driven by increasing macroeconomic risk (E49) |
| unmeasured intangibles (H82) | reduces estimated influence of market power (D43) |