MNI: US Neutral Rate Likely To Remain Low - Brookings Paper

The U.S. neutral real rate of interest is likely to remain low for the foreseeable future, but a sharp turnaround in r-star to levels not seen since before the Global Financial Crisis is possible if a number of adverse scenarios play out concurrently, according to a paper authored by Lukasz Rachel to be presented at the Brookings Institution Thursday. 

Rachel's paper estimates the current real natural rate in advanced economies for safe assets at around 0% to 1.2%. "That’s down substantially from more than 7% in the early 1980s, but mostly below what the market expects," he wrote in a summary provided by Brookings.  

Policymakers can use estimates of the neutral interest rate to assess whether a specific policy stance corresponds to loose or tight monetary policy. The median FOMC official sees the long-run neutral interest rate at 3.0%, although officials' estimates currently range from 2.9% to 4.4%. (See: MNI POLICY: Lively Debate At Fed Over Possible R-Star Rise)

A reversal of low rates is possible, Rachel argues, but it would require a bunch of risk scenarios to hit the economy all at once to generate a neutral rate of 3% of more. 

"For r-star to return to levels last seen before the global financial crisis, several of the upside risks would need to materialize all at once, which might not be very likely," said Rachel.

The paper examines several upside-risk scenarios that might plausibly contribute to the reversal of the long-run trend. Artificial intelligence, if it boosts economic productivity as many experts expect, would increase businesses’ demand for capital and reduce households’ desired saving, raising r-star steadily, perhaps by 1 percentage point over the next five years, Rachel wrote. 

"More immediately, investors might push the neutral rate up by a similar amount if they infer from the large recent losses on their portfolios of nominal government bonds that 'safe' assets are not so safe after all," Rachel said.