How will the real interest rate conundrum be resolved? - Natixis

In OECD countries, real long-term interest rates are now much lower than real growth and therefore normally the marginal productivity of capital too, which is essentially due to the highly expansionary monetary policies, according to Patrick Artus, Research Analyst at Natixis.

Key Quotes

“Yet in the long term, the real long-term interest rate should be close to the real growth rate: how will this rebalancing take place if monetary policies remain expansionary?”

“There are two possibilities:

  • Either the low real interest rates lead to an increase in capital accumulation, reducing the marginal productivity of capital (given the diminishing returns on capital); the rebalancing would then take place via an overaccumulation of capital followed by a fall in growth;
  • Or central banks keep nominal interest rates low and, with no change in the real long-term interest rate, which is determined by features of the real economy, inflation must fall to lift the real interest rate from its current low level. The rebalancing would then take place via deflation (a fall in inflation) under a “Neo-Fisherian” logic.”

“In the long term, the real interest rate and the growth rate will have to rebalance. The question is how this rebalancing, which has yet to get under way, will take place.”

“The question is which mechanism will reconcile the real interest rate and real growth

Even if monetary policy remains enduringly expansionary, in the long term the real interest rate and real growth must converge.

There are two ways this convergence can take place:

- Via an overaccumulation of capital and therefore a fall in the marginal productivity of capital and in real growth;

- Via a fall in inflation which increases the real long-term interest rate if the nominal interest rate remains enduringly low.

In any event, the question is which mechanism will inevitably lead the real interest rate and real growth to rebalance in the long term. This rebalancing is yet to get under way.”

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