The Natural Rate of Interest — Concepts and Appraisal for the Euro Area

Real interest rates in the euro area fluctuated sharply between —4.2% and +7.7% over the past half century. A key question for monetary policy makers and economic agents is: What is the „neutral,” „equilibrium” or „natural” real interest rate to which current rates might eventually move back? In the long run, the natural rate of interest is influenced by productivity developments, population growth and the time preference for consumption over saving. In the medium run, the natural rate may also be influenced by fiscal policy, the structure of financial markets, and inflation risk premiums. Globalization should over time contribute to an international convergence of natural rates. Empirical estimates of the natural rate differ considerably and are associated with large error margins; estimates in „real time” suffer from additional uncertainty. Monetary policy rules based on the natural rate (e.g. Taylor rules, real interest rate gap) should thus be treated with great caution. Monetary policy might use the natural rate to consider appropriate responses to technological and demographic shocks. The majority of recent estimates for the euro area points to a fall in the natural rate to a level as low as 1.5%. This may reflect a more credible monetary policy and deep euro area financial markets, but also slowing productivity growth and a decline in the working-age population. In the future, the growing need for private savings for retirement might lower the natural rate, whereas „fiscal consolidation fatigue” might raise the natural rate.