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| natural rate of interest | |
|---|---|
| Name | Natural rate of interest |
| Other names | r* |
| Field | Macroeconomics |
| Introduced | 19th century (conceptual), formalized 20th century |
| Notable figures | Knut Wicksell; John Maynard Keynes; Irving Fisher; Milton Friedman; Edmund Phelps; Lars Svensson |
natural rate of interest The natural rate of interest is a theoretical real interest rate at which an economy's output is at potential and inflation is stable, connecting long-run equilibrium in models of capital and intertemporal allocation. It appears across macroeconomic traditions and policy debates involving central banking, growth accounting, and asset pricing. Scholars and institutions use the concept to interpret signals from financial markets, fiscal regimes, and demographic trends when considering policy frameworks.
The concept draws on classical and neoclassical ideas from figures such as Knut Wicksell, Irving Fisher, John Maynard Keynes, Milton Friedman, and Edmund Phelps to describe an equilibrium real interest rate compatible with full employment and stable prices. In dynamic stochastic general equilibrium approaches prominent at European Central Bank and Federal Reserve research units, the natural rate equals the return on capital when nominal rigidities and expectations are neutralized, linking to models by Robert Lucas (economist), Finn Kydland, and Edward Prescott. Formalizations appear in New Keynesian frameworks used by Ben S. Bernanke, Janet Yellen, and Paul Krugman to justify Taylor-rule style prescriptions and derive output gaps relative to potential measured by Simon Kuznets-style trends.
Early roots trace to the price-specie flow debates and classical political economy with antecedents in writings of Jean-Baptiste Say, David Ricardo, and John Locke on interest and capital. Knut Wicksell's late 19th-century lectures crystallized the modern notion by contrasting the "natural" and "market" rates, influencing later work by Irving Fisher and John Maynard Keynes. Mid-20th-century developments by Milton Friedman and Edmund Phelps connected the idea to expectations and inflation dynamics, while the rise of macroeconometric modelling at institutions such as the International Monetary Fund, Bank of England, and Federal Reserve Bank of New York fostered empirical estimation techniques pursued by researchers like Thomas Laubach and John C. Williams.
Estimating the natural rate is inherently unobservable, prompting statistical methods including structural time-series models, Kalman filtering, and dynamic general equilibrium estimation used by researchers at European Central Bank, Federal Reserve Board, and Organisation for Economic Co-operation and Development. Prominent approaches include the Laubach–Williams model, vector autoregressions employed by Christiano Eichenbaum, and full-information maximum likelihood in DSGE implementations influenced by Christopher Sims and Thomas Sargent. Market-based proxies draw on long-term real bond yields traded in New York Stock Exchange, London Stock Exchange, and Euronext markets, while yield curve decomposition techniques popularized by John Campbell and Glen Hubbard compare nominal yields with expected inflation series from University of Michigan surveys and Bureau of Labor Statistics indices.
The natural rate is shaped by factors emphasized by growth and distribution theorists including Robert Solow, Trevor Swan, Simon Kuznets, and Robert Barro: productivity growth, preferences for consumption versus saving rooted in utility representations by Paul Samuelson, and demographic forces studied by Alvin Hansen and Nathaniel Weyl. Capital accumulation and technological progress as in Harrod-Domar and Solow-Swan frameworks alter the marginal product of capital, while international capital flows involving institutions like Bank for International Settlements and World Bank transmit persistence. Fiscal policy regimes associated with figures such as James Buchanan and Ricardo-style public debt considerations modify equilibrium via intertemporal budget constraints formalized by Olivier Blanchard.
Empirical studies by Thomas Laubach and John C. Williams for the Federal Reserve suggest a declining r* in advanced economies since the 1980s; corroborating cross-country analyses from International Monetary Fund and Bank for International Settlements show low real rates in Japan, Germany, and United States. Research by Christoph Gourinchas and Hélène Rey highlights global savings gluts influenced by emerging market reserves accumulation in China and sovereign wealth flows from Norway and United Arab Emirates. Time-series evidence from researchers at European Central Bank indicates cyclical and secular components, while panel econometrics by Michael Kremer-style scholars link demographic transitions in Italy and Spain to lower equilibrium rates.
Central bankers such as Paul Volcker, Alan Greenspan, Mario Draghi, and Christine Lagarde use estimates of the natural rate to set policy stances, often via variants of the Taylor rule and forward guidance. A lower r* constrains nominal interest rate space, increasing the likelihood of the effective lower bound and quantitative easing programs implemented by Bank of England, Federal Reserve System, and European Central Bank. Fiscal-monetary interactions spotlight debates involving Ben Bernanke and Lawrence Summers over secular stagnation, debt sustainability discussions influenced by Kenneth Rogoff and Carmen Reinhart, and alternative policy mixes advocated by Janet Yellen.
Critics including heterodox and post-Keynesian authors challenge the empirical tractability and normative use of the natural rate, with methodological critiques from Thomas Piketty on distributional drivers and from Hyman Minsky on financial instability dynamics absent from r* calculations. Alternative frameworks emphasize credit, banking, and institutional structure as in work by Charles Goodhart, Marc Lavoie, and Willem Buiter, while New Classical skeptics like Robert Lucas (economist) question usefulness under rational expectations. Debates persist at forums such as meetings of the American Economic Association and policy conferences at Brookings Institution and National Bureau of Economic Research.