Natural Rate of Interest to Stay Low, Fed's Williams Says

The natural rate of interest, or r-star, "will not reverse anytime soon," Federal Reserve Bank of San Francisco President and CEO John C. Williams wrote in an Economic Letter published Tuesday.

Eight years after the financial crisis began, "there are no signs of a return to more historically normal levels of r-star," Williams wrote. "This suggests that these low estimates of r-star are not overly influenced by country-specific cyclical factors, but instead that longer-term global influences are at work."

Also, factors dampening "r-star across countries reflect highly persistent forces affecting the global supply and demand for savings."

It is unclear "the causes and consequences of the decline," he said. "[E]xpected returns on a wide set of assets have declined as r-star has fallen. In addition to the evidence on expected returns, the sizable decline in trend growth across the large advanced economies suggests that forces related to real economic activity are at play in determining the natural rate of interest …"

Williams wrote, "[T]he global nature of the decline in r-star implies that central banks will face daunting challenges in stabilizing their economies in response to negative shocks when interest rates are not far above their lower bound."

Previously termed "extraordinary" policies — like zero or negative interest rates, forward guidance, and balance sheet policies — are likely to become the norm as central banks strive to achieve their macroeconomic goals."

Risks to financial stability could be greater in a low r-star environment, and policymakers should prepare for these challenges, he said.

For reprint and licensing requests for this article, click here.
MORE FROM BOND BUYER