The macroeconomic debate on the natural rate of interest (r∗) raises key questions about the long-term cost of capital in the United States. This rate represents the real interest rate expected when the economy reaches full employment and stable inflation. After decades of steady decline before the pandemic, estimates of r∗ rose by roughly one percentage point after 2020.
To explain this shift, analysts usually point to two main drivers. First, they highlight expectations of growing public debt. Second, they focus on productivity gains from generative Artificial Intelligence (AI). However, a recent study by Jens H. E. Christensen and Glenn D. Rudebusch for the Hutchins Center at Brookings challenges this narrative. The authors show that these factors fail to explain the rise in the equilibrium rate.
High-Frequency Event-Study Methodology and Empirical Findings
The researchers used a high-frequency event study to test these common explanations. Specifically, they isolated how fiscal policy news, major AI releases, and monetary communications affected market yields and r∗ estimates.
Consequently, their empirical results challenge conventional market views:
- Fiscal Policy: Fiscal news in the United States created only minor upward pressure. Thus, it cannot justify the sustained rise in the natural rate.
- Artificial Intelligence: Markets often assume that AI increases capital demand and raises real rates. In contrast, major AI announcements actually had a slight downward effect on measured r∗.
- Monetary News: In addition, Federal Reserve communications failed to account for the shift. Monetary news did not produce lasting changes in long-term equilibrium yields.
Implications for Global Economic Policy
Therefore, the study concludes that other underlying structural forces are driving the natural rate upward. These unknown forces outweigh the downward pressures from technological shifts and demographic savings patterns.
In practice, identifying the true drivers of r∗ remains critical for economic policy. For instance, the natural rate serves as the baseline to determine if monetary policy is tight or loose. Furthermore, it sets the threshold for public debt sustainability. If the rise in r∗ stems from unidentified structural shifts rather than AI productivity or deficits, high interest rates may persist much longer than expected.
Reference
Christensen, J. H. E., & Rudebusch, G. D. (2024, May 22). Can fiscal, AI, or monetary news explain the rise in r?*. Brookings Institution. https://www.brookings.edu/articles/can-fiscal-ai-or-monetary-news-explain-the-rise-in-r/