One of the more remarkable claims since the financial crisis of 2008 is that the natural rate of interest is now below zero, and it has been below zero since the financial crisis.
If you look at the very best estimates of the natural rate of interest over the last 50 years, one broad fact is pretty clear–it’s been around 2 1/2% for nearly the entire time leading up to the financial crisis of 2008. Here is a good estimate we have for the natural rate of interest, which is shown in the graph below, shows a slow moving, consistent natural rate of interest of around 2 1/2%.
Yes, there are swings in this estimate of the natural rate of interest during the time before the financial crisis. But overall, for many decades, the estimated NRoI was positive and quite consistently parked at level well above zero.
Note the Eurozone estimate from 2007, not long before the financial crisis hit.
It seems extremely unlikely to me that something which was estimated to be so consistent over such a long period of time when suddenly fall to an entirely new level. Over the time shown in this graph, there were large structural changes in the economy, but the estimated NRoI did not change much.
These structural changes to the economy were not trivial changes. We went from a largely fiscally managed economy in the 1960s to the big monetarist break under Paul Volker, where the world became a primarily monetarily managed economy. Inflation ranged anywhere from 2% to nearly 15% in the United States. The debt to GDP ratio fluctuated from over 100% in the 1950s to under 60% in the 1970s, and then began to grow again under Regan. Nixon instituted price controls in the 1970s, and Reagan dramatically lower tax rates on the wealthy in the 1980s. These are just some of the enormous changes in our economy which happened over the last 50 years.
This does not even capture the amazing changes which happened in the dollar sphere of influence over these decades. The dollar went from an astonishingly dominant position in the post World War II era to being challenged by Japan and then the euro in the 2000. We broke up the Bretton Woods agreement, closed the gold window, and went to a floating exchange rate regime worldwide. Yet despite all these incredible changes in economic environment, the estimated natural rate of interest remained almost constant.
Now back to the world today and the current estimate of the NRoI. People are routinely claiming you natural rate of interest is below zero. Smart people like Miles Kimball and David Beckworth are good examples of people who strongly believe the natural rate of interest is below zero today.
What happened which could compel such a sea change in the NRoI? How is it that something supposedly so “fundamental” to our economy could have a quantum break to an entirely new level, a break larger than any slow gradual change it has shown in generations?
Even more interestingly, the NRoI is supposed to show the where interest rates should be to keep the economy on an equilibrium with inflation. Inflation has an expectation of future price increases baked into its very nature. How could the NRoI be high and above zero in 2007?