A secular increase in the equity risk premium

There is an increasing consensus that global ‘excess saving’ has contributed to a reduction in equilibrium real interest rates. While economists dispute the extent of the decline, few now question that a decline has taken place or that excess saving has played a causal role. A key implication of this narrative is a decline in yields of all assets, including but not restricted to government bond yields. Yet, since the turn of the century, yields on global equity have risen. A complementary explanation is that there has been an increase in the global equity risk premium (ERP), which has simultaneously pushed risk-free yield curves lower and equity yields higher. Applying a sign restrictions approach, I find that excess savings shocks were the predominant force affecting global real bond yields between the mid-1980s and 2000 but that ‘risk premium’ shocks have accounted for more of the decline in real bond yields since 2000.