The equilibrium real interest rate is just above zero, Federal Reserve Bank of San Francisco researchers wrote in an Economic Letter released Monday.

"From 1998 to the end of 2016, we estimate that the equilibrium real rate fell from just over 2% to just above zero," write Jens H.E. Christensen, a research advisor in the Economic Research Department of the San Francisco Fed, and Glenn D. Rudebusch, a senior policy advisor and executive vice president in the department. "Accordingly, our results show that about half of the 4 percentage point decline in longer-term Treasury yields during this period represents a reduction in the natural rate of interest."

The Federal Reserve Bank of San Francisco building.
The Federal Reserve Bank of San Francisco building.

The rate was calculated based on prices of inflation-indexed bonds. Inflation-indexed bonds, "compensate investors for the erosion of purchasing power due to price inflation, so they provide a fairly direct reading on real interest rates."

While the economy recovers from the great recession, interest rates remain "unusually low," and are expected to stay low. The belief has been "that yields have been pushed down by declines in longer-run expectations of the normal inflation-adjusted short-term interest rate — that is, by a drop in the so-called equilibrium or natural rate of interest."

Christensen and Rudebusch determined "a decline in this rate has indeed contributed about 2 percentage points to the general downward trend in yields over the past two decades."

The equilibrium rate offers a neutral benchmark for officials determining monetary policy. "For investors, this short-term real rate of return that would prevail in the absence of transitory disturbances serves as a key foundation for valuing financial assets," the authors say.

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