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Measuring the Natural Rate of Interest Redux

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Measuring the Natural Rate of Interest Redux

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5 min read
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Central bankers Thomas Laubach and John C. Williams show that the natural rate of interest has sunk to a new – and possibly enduring – low.

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Editorial Rating

8

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  • Innovative

Recommendation

Are low interest rates the new normal? In this provocative report, central bankers Thomas Laubach and John C. Williams suggest that the natural rate of interest – the rate that prevails when national output is at its potential – has moved to a permanently low level. Though their study doesn’t take into account structural changes that could hike GDP, such as the impact of new technologies, their model lays out a strong case for an ongoing low-interest rate environment. getAbstract suggests that economists, investors and policy makers read this informative, topical report.

Summary

In 1898, economist Knut Wicksell defined the natural, or equilibrium, interest rate as “a certain rate of interest on loans which is neutral in respect to commodity prices, and tends neither to raise nor to lower them.” Essentially, it is a short-term real interest rate at which the economy performs at its maximum capacity after any temporary jolts to supply and demand have subsided. Since the Great Recession, the natural rate of interest has fallen to historical lows of 0%. Despite economic recovery, the rate has shown no sign of moving up.

Defining the natural rate of interest is easier than actually measuring it. One way ...

About the Authors

Thomas Laubach is director of the Board of Governors of the Federal Reserve System, and John C. Williams is president of the Federal Reserve Bank of San Francisco.

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