Drivers of the natural long-term rate of interest (and why the economy hasn't tanked)

Long-term borrowing costs have been on a path of near continuous decline for the last several decades, with huge consequences for asset values, government finances, borrowers and savers. To shed light on why, we have estimated a global model that brings together an extensive set of drivers of the natural rate of interest for 12 advanced economies, using data spanning half a century. We find that slower growth and the age structure of the population accounted for about half of the three percentage point decline in the real natural rate for the USA between 1970 and a trough in the mid-2010s. Global spillovers account for a bit more than a third of the decline. Our model suggests the natural rate in the USA has climbed more than half a percentage point since the trough, partly reflecting extraordinary fiscal stimulus in the USA. Rather than on overnight rates, our model is estimated on 10-year borrowing costs. That is because monetary policy has increasingly relied on squeezing the whole yield curve to support demand. Importantly, when viewed through a longer-term lens, US monetary policy does not look as tight as it does when looking at short-term rates alone. This may help to explain why the economy has been so resilient to the post-pandemic hiking cycle.