The Global Equilibrium Real Interest Rate: Concepts, Estimates, and Challenges

Real interest rates have been persistently below historical norms over the past decade, leading economists and policy makers to view the equilibrium real interest rate as likely to be low for some time. Various definitions and approaches to estimating the equilibrium real interest rate are examined, including approaches based on the term structure of interest rates and small macroeconomic models. The individual country approaches common in the literature are extended to allow for global trend and cyclical factors. The analysis finds that global factors dominate the downward trend in the equilibrium interest rate across 13 advanced economies. A corollary of this finding is that the U.S. equilibrium rate can be informed by global developments and is recently lower than estimated in U.S.-only studies. The analysis also highlights how the common global trend confounds empirical assessments of the determinants of movements in the equilibrium rate and the need to better integrate term-structure and macroeconomic approaches.

Discounting Future Climate Change and the Equilibrium Real Interest Rate

<p>The social discount rate is a crucial element required for valuing future damages from climate change. A consensus has emerged that discount rates should be declining with horizon, i.e., that the term structure of discount rates should have a negative <em>slope</em>. However, much controversy remains about the appropriate the overall <em>level</em> of discount rates.</p><p>We contribute to this debate from a macro-finance perspective, based on the insight that the equilibrium real interest rate, commonly known as r*, is the crucial determinant of the level of discount rates. First, we show theoretically how r* anchors the term structure of discount rates, using the modern macro-finance theory of the term structure of interest rates to provide a new perspective on classic results about social discount rates. Second, we show empirically that new macro-finance estimates of r* have fallen substantially over the past quarter century---consistent with a broader literature that documents such a secular decline. Bayesian estimation of a state-space model for Treasury yields, inflation and the real interest rate allows us to quantify both the decline in r* and the resulting downward shift of the term structure of social discount rates. Third, we document that this decline in r* and the social discount rate boosts the social cost of carbon and has quantitatively important implications for assessing the economic consequences of climate change. In essence, we demonstrate that the lower new normal for interest rates implies a higher new normal for the present value of climate change damages.</p>

Monetary Policy and Unnatural Low Interest Rates: Secular Stagnation or Financial Repression?

Market interest rates have been on a declining trend over the past 35 years in all advanced economies, even reaching negative territory in some European jurisdictions. This article reviews two competing explanations for the occurrence of unnatural low interest rates. The secular stagnation hypothesis of Keynesian origin maintains that persistent non-monetary factors have caused a structural excess of desired savings over planned investments which steadily pushed down the equilibrium real interest rate that is consistent with a balanced economy. Major central banks in turn failed to sufficiently lower their monetary policy rates to revive aggregate demand, leading to anaemic economic recoveries and hysteresis effects. By contrast, the financial repression doctrine argues that central banks pursued low interest rates to ease the government budget constraint and serve political objectives. The Austrian School of Economics states that this monetary easing bias sowed the seeds of repeated boom/bust cycles and created economic distortions that dragged down potential growth and the equilibrium real interest rate. The core of the debate appears to be the long-standing controversy about the desirable role for the state in guiding the economy on a higher potential growth path as opposed to relying on the efficiency of market processes in generating prosperity.

Monetary Policy, Financial Stability, and the Zero Lower Bound

Much has happened in the world of central banking in the past decade. In this paper, I focus on three issues associated with the zero lower bound (ZLB) on short-term nominal interest rates and the nexus between monetary policy and financial stability: 1) whether we are moving toward a permanently lower long-run equilibrium real interest rate; 2) what steps can be taken to mitigate the constraints imposed by the ZLB; and 3) whether and how financial stability considerations should be incorporated in the conduct of monetary policy. These important topics deserve the attention of both academic and government professionals.