Every atomic assertion extracted from the underlying record, ranked by evidence strength.
Real interest rates have seen a measurable and persistent rise across many advanced economies over the past two years.
This rise partly reverses a secular decline in real interest rates that began in the early 1980s.
The savings-investment hypothesis argues that structural determinants of global saving and investment are the ultimate drivers of the natural rate of interest, and hence real long-term rates, which are anchored around r*.
The monetary policy hypothesis argues that monetary policy may have played a role in the persistent downward trend and subsequent rise in real interest rates.
Isabel Schnabel delivered a speech at The ECB and its Watchers XXIV Conference session on Geopolitics and Structural Change: Implications for Real Activity, Inflation and Monetary Policy in Frankfurt on March 20, 2024.
Exceptional investment needs arising from structural challenges related to the climate transition, the digital transformation and geopolitical shifts may have a persistent positive impact on the natural rate of interest.
Central banks shaping investors' beliefs about r* may even result in informational feedback loops.
Uncertainty about how central bank actions and communication affect real long-term rates suggests that policymakers need to tread carefully.
Whether the anticipation of these investment needs has directly been driving real rates higher in recent years, or whether monetary policy has been a catalyst for the repricing, remains subject to discussion.
Informational feedback loops, inducing shifts in r*, may result if the signal inferred from central banks has an impact on private consumption and investment decisions.
Under the savings-investment hypothesis, monetary policy merely responds to global structural changes.
Under the monetary policy hypothesis, monetary policy may have long-lasting effects on economic activity.
Real short- and long-term risk-free interest rates globally experienced a gradual and persistent decline in the decades following the inflation spikes of the 1970s and early 1980s.
Model estimates indicate that r* followed a persistent downward trend over the past decades leading up to the pandemic.
There is some disagreement about the precise level of r* due to high model and estimation uncertainty.
Real long-term rates should align closely with r* over the long run, once the impact of temporary demand or supply shocks has faded and the economy has moved back into equilibrium.
r* serves as an anchor for real long-term rates.
The downward trend in real interest rates appears to have reversed over the past two years.
Real long-term yields have increased considerably across advanced economies.
The rise in real long-term yields reflects a reassessment by market participants of the expected level of real short-term interest rates prevailing in the future.
Respondents to the Survey of Monetary Analysts (SMA) expect the ECB's deposit facility rate (DFR) to level off in a range between 2% and 2.5% over the long run.
Given an expected inflation rate of 2% over the same horizon, an expected DFR of 2% to 2.5% would correspond to an r* of 0% to 0.5%.
The ECB's model-based estimates have shown a similar upward trend for r*.
These r* estimates are around one percentage point higher than before the start of the monetary policy tightening cycle in December 2021.
Median survey expectations and model estimates of real short-term rates were in negative territory before December 2021.
Market-based proxies of r* in the euro area have increased measurably since late 2021.
The shift in market-based r* proxies is even more pronounced in the United States.
Market participants in the United States price an expected average real short-term rate of above 1% over the long run, which is substantially higher than in 2021.
Within a standard macroeconomic framework, changes in equilibrium real interest rates are determined by structural shifts in savings and investments.
An increase in desired investment, for a given level of desired savings, puts upward pressure on real interest rates.
In a world with free capital flows, real interest rates are determined globally.
Over the long run and without any frictions in financial markets, there exists a single equilibrium interest rate that clears the global capital market.
Global r* acts as an anchor for domestic r*.
Proponents of the savings-investment hypothesis explain the fall in r* and real long-term rates pre-pandemic by a trend decline in productivity growth.
The trend decline in productivity growth lowered the marginal return on capital, thereby reducing the demand for investment.
A persistent rise in savings, termed the "global saving glut" by Ben Bernanke, was a second key driver behind the fall in r* pre-pandemic.
Large current account surpluses in emerging market economies with shallow financial markets led to a rise in savings, exerting downward pressure on r*.
Higher risk aversion after the global financial crisis contributed to an increase in desired savings.
Demographic forces, such as higher life expectancy and longer retirement, further contributed to an increase in desired savings.
Recent research suggests that the bulk of the decline in global r* since the 1970s can be attributed to slowing productivity growth and rising longevity.
The natural rate of interest can be conceptualized as having a very slow-moving long-run component and a more cyclical component that can drive it away from its long-run trend over a protracted period.
Real interest rates have oscillated around a persistent downward trend since the start of the Renaissance in the 14th century.
Temporary but protracted reversals in the interest rate regime occurred at times of major and persistent structural shocks, such as the Black Death in the 1350s or extended periods of war.
After the Second World War, major investment was needed to reconstruct the European and parts of the global economy, which put upward pressure on r* over several decades until it started to decline in the 1980s.
It is possible that the fundamental forces driving our economies in the long run have not changed, despite the series of shocks witnessed in recent years.
An ageing global population and continued subdued productivity growth may remain a drag on real interest rates.
Overcoming current challenges may ultimately require changes to our economy large enough to offset fundamental forces over the coming years, and possibly beyond.
Climate change and the green transition will require exceptionally high investment.
Geopolitical shifts due to the Russian invasion of Ukraine and tensions between the United States and China will require exceptionally high investment.
Rapid advances in artificial intelligence and digitalization will require exceptionally high investment.
The transformation towards a climate- and nature-preserving economy may necessitate investments comparable to what was required to rebuild the European economy after the Second World War.
Annual investment in the energy system in the 2020s needs to be twice as high as in the preceding decade to meet the objectives of the Fit for 55 package, according to estimates by the European Commission.
The higher frequency of extreme weather events is likely to necessitate extensive public and private investments for both rebuilding and adaptation.
The number of billion-dollar disasters in the United States rose exponentially from just three on average in the 1980s to 28 in 2023.
Benefiting from rapid advances in artificial intelligence and exploiting the full potential of digitalization will require large public and private sector investments in physical and human capital for acquiring and implementing new technologies and reshaping business processes.
Such investments will be particularly large in the EU, which has been lagging the United States and China markedly over the past years.
Companies seeking to make their supply chains more resilient by diversifying sourcing strategies will generate another major push towards higher investment.
An ECB survey indicates that leading firms operating in the euro area expect to become much more active in near-shoring or friend-shoring operations over the next five years to make their businesses more resilient.
Geopolitical risks and climate change are seen as the two most important factors for relocating production and business operations to the EU.
Such relocation could unleash a new wave of capital investment in physical infrastructure.