The World's Interest Rate Puzzle: Has the Pandemic Shifted the Global Economic Landscape?
The COVID-19 pandemic upended lives and economies, but its impact on a crucial economic indicator, the natural rate of interest (r), is still being debated. *But here's where it gets controversial:** could the pandemic have actually reversed a decades-long decline in global r*?
This post delves into the fascinating world of global interest rates, using a sophisticated econometric model called 'trendy VAR' to analyze data from 18 developed countries. This model, developed by Del Negro, Giannone, Giannoni, and Tambalotti, allows us to identify a common trend in real interest rates across these nations, which we term the 'global r*'.
And this is the part most people miss: Before the 1980s, r* varied widely across countries. However, financial market integration in the late 1980s seemingly erased these differences, leading to a truly global r. This means that the decline in r from the 1990s until the pandemic, and its subsequent rise post-pandemic, are not isolated events but part of a global phenomenon.
Our analysis, inspired by Lukasz Rachel's insightful Brookings paper, reveals a striking pattern. Global r* plummeted from around 3% in the early 1990s to below 0% after the financial crisis, continuing its descent in the 2010s. However, it rebounded by roughly 1 percentage point after COVID-19. Interestingly, the U.S. r* has largely mirrored this global trend since the late 1980s, though it experienced a steeper decline following the financial crisis. By 2024, both global and U.S. r* estimates hover around 0.5%, though with significant uncertainty surrounding these figures.
Is this post-pandemic rise in r* sustainable? The drivers behind this increase are complex. While a decline in the 'convenience yield' – the premium investors demand for holding safe and liquid government bonds – explains about one-third of the rise, other factors are at play. Could it be a harbinger of an AI-driven productivity boom? Or perhaps the looming specter of rising debt-to-GDP ratios, fueled by aging populations and potential increases in military spending? Rachel's paper explores these possibilities, suggesting that both could be contributing factors, though the model struggles to fully explain the abruptness of the rise.
The implications of a sustained increase in global r* are profound. It could signal a shift in the global economic landscape, potentially impacting investment, growth, and inflation. What do you think? Is the post-pandemic rise in r* a temporary blip or a sign of a new economic era? We invite you to join the discussion in the comments below.
For those interested in delving deeper, the data and replication code for our analysis are available on GitHub [link]. We aim to update these estimates as new data becomes available, providing ongoing insights into this crucial economic indicator.
Disclaimer: The views expressed herein are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.
