Natural and Neutral Real Interest Rates: Past and Future

This paper surveys the decline in real interest rates in advanced and emerging economies over the past several decades, linking that process to a range of global factors that have operated with different force in different periods. The paper argues that estimates of long-run equilibrium real rates (r̄) may not always furnish an accurate guide to the rate appropriate for short-term monetary policy (r*). It argues further that effective monetary should consider not only equilibrium in the market for domestic goods, but also the current account balance, financial conditions (including capital flows), and imperfect policy credibility. Equilibrium long-term real interest rates have risen recently according to market indicators. However, the main underlying factors that have pushed real interest rates down since the 1980s and 1990s – notably demographic shifts, lower productivity growth, corporate market power, and safe asset demand relative to supply – do not appear poised to reverse strongly enough to drive a big and durable rise in global real interest rates over the coming years. Low equilibrium interest rates may well continue periodically to bedevil monetary policy and financial stability.