The global real interest rate: past developments and outlook

The real interest rate (i.e. the nominal return on assets after discounting for expected inflation) is a key macroeconomic variable since it determines economic agents’ intertemporal investment and consumption decisions. The equilibrium real interest rate is that which equates the supply (saving) and demand (investment) for loanable funds or, in other words, makes the marginal productivity of capital equal to the compensation that savers require to delay their consumption. This concept is closely linked to the “natural” real interest rate habitually used in the business cycle literature, which is defined as that consistent with the use of all the productive resources in an economy without any type of financial or real frictions (Wicksell, 1898). This natural interest rate measures the return associated with the economy’s potential growth and depends on fundamental parameters such as productivity and population growth, and the elasticity of intertemporal substitution, which measures consumers’ readiness to delay their consumption. The growing trade and financial integration of recent decades has seen real interest rates in every economy increasingly influenced by international developments. The progressive opening up of economies, with growing trade and financial flows, has enabled economies with investment requirements not covered by their domestic saving to resort to other countries’ excess saving, such that financing flows towards countries where it is more profitable, generating global gains. Accordingly, a global real interest rate may be defined as that which equates the supply and demand for loanable funds at the global level. From this perspective, real interest rates are increasingly determined by factors common to all countries that depend on saving and investment at the global level. There is wide evidence that real interest rates have progressively declined since the 1980s in most advanced and emerging economies to stand currently at very low levels. The persistence and intensification of this trend during the global financial crisis led to consideration of a series of highly relevant issues in different areas (Teulings and Baldwin, 2014). First, it can be asked to what extent the task of monetary policy of steering the interest rate towards its natural level is made more difficult by the fact that this natural interest rate may be very low (or even negative, if adverse macroeconomic shocks occur), given the current context of persistent low inflation rates, which means that nominal interest rates need to be significantly negative (Summers, 2014). Further, the existence of excessively low interest rates for prolonged periods raises the question of the implications for financial stability. Lastly, there is the question of whether this situation is actually the reflection of a substantial reduction in potential growth at the global level. Against this background, this article analyses the determinants of this trend from a global perspective, discussing the extent to which it is likely to continue in the medium and long term. In this connection, the following section reviews the main stylised facts relating to real interest rate developments. The third section discusses the determinants that the literature has related to the trends observed, differentiating between various time periods and highlighting the influence of the emerging economies, since the beginning of this century, and of other factors that have operated in the wake of the global financial crisis. The fourth section discusses some medium and long-term trends that may affect the future course of interest rates.