Natural rate of interest

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The natural rate of Interest (NRI), sometimes called the neutral rate of interest[1], is the interest rate that supports the economy at full employment/maximum output while keeping inflation constant.[2] It cannot be observed directly. Rather, policy makers and economic researchers aim to estimate the NRI as a guide to monetary policy, usually using various economic models to help them do so.


The concept was originated by the Swedish economist Knut Wicksell who published a paper in 1898 defining it as a real short-term rate that makes output equal to natural output with constant inflation. Specifically, Wicksell defined the NRI as “a certain rate of interest on loans which is neutral in respect to commodity prices and tends neither to raise nor to lower them”.

No significant work on the idea of a NRI followed Wicksell’s paper, perhaps because at that time central banks were not targeting interest rates. Almost a century later, during the 1990s as central bank policy targets started changing, the NRI concept began attracting attention.The US Federal Reserve decision to adopt the short term interest rate as its primary control of inflation led to growing research interest into the topic of the natural rate of interest. Using macroeconomic models, the NRI can be defined as that rate of interest where the IS curve intersects with the potential output line (a vertical line cutting the X-axis at the value of potential GDP).[3] ∆πt

Recent discussion[edit]

A good deal of recent discussion about economic policy, both in the US and internationally, has centered around the idea of the NRI.[4] Following the Financial crisis of 2007-2008 (sometimes known as the "global financial crisis", or GFC), key central banks in major countries around the world expanded liquidity quickly and encouraged interest rates (especially short-term interest rates) to move to very low levels. This approach led to much discussion among economic policy makers as to what the appropriate levels of interest rates (both in the short-term, and in the long-term) might be.


Among economic policy makers, in official and academic papers, the NRI is often depicted as r* ("r-star").[5] The president of the New York Fed, John Williams, has written extensively about the NRI[6] and has even said, lightheartedly, that he "has a passion for r-star".

R-star (the NRI) is of particular interest because key economic issues for economic policy makers, at any time, revolve around the relationship between current long-term interest rates and r-star. Questions arise, for example, as to whether current rates are below or above r-star, and if there is a significant gap between current rates and r-star, how quickly the gap should be closed. Broader issues also attract much debate, such as whether the global NRI ("global r-star") is stable or whether it is tending to drift up or down over time -- and if it is tending to drift, what are the underlying factors (economic, social, demographic) that are causing the change.[7]

Other "star" variables

Senior economic policy makers and other economists often discuss the level of the NRI (r-star) in relation to several other key economic variables, sometimes also seen as "stars". In August 2018, the Chairman of the United States Federal Reserve System (the "FED"), Jay Powell, discussed the relationships between several of these main stars in some detail.[8] Powell noted that the NRI needed to be considered in relation to the "natural rate of unemployment" (which Powell noted is often referred to as "u-star", written u*) and the inflation objective ("pi-star", written Π*). Powell then went on to note that the conventional approach to economic policy making was that "policymakers should navigate by these stars". However, he said, although navigating by the stars can sound straightforward, in practice "guiding policy by the stars ... has been quite challenging of late because our best estimates of the location of the stars have been changing significantly." Powell reviewed the history of attempts to estimate the location of the "stars" over a 40-year period 1960-2000 and noted that over time, there had been significant revisions of estimates of the positions of the stars.

Variations between countries

Estimates of the NRI vary between countries. This is because the underlying factors influencing the NRI are believed to vary between countries. Estimates of the NRI in Australia carried out in 2017 in the Reserve Bank of Australia, for example, suggest that the NRI in Australia is perhaps somewhat higher than in the US/Euro area.[9]


  1. ^ Federal Reserve Bank of San Francisco, 'What is neutral monetary policy?', April 2005.
  2. ^ Olson, David Wessel and Peter (October 19, 2015). "The Hutchins Center Explains: the Natural Rate of Interest". Brookings. Retrieved 2017-09-18.
  3. ^ Laubach, Thomas (March 13, 2006). "Measuring the Natural Rate of Interest". The Review of Economics and Statistics. 85 (4): 1063. doi:10.1162/003465303772815934. Retrieved 5 September 2017.
  4. ^ "A natural long-term rate", The Economist, 26 October 2013. Retrieved 28 May 2018.
  5. ^ Gavyn Davies, 'What investors should know about R star', The Financial Times, 12 September 2016.
  6. ^ President's speeches, Speeches by John C. Williams, President and CEO, Federal Reserve Bank of San Francisco.
  7. ^ John Williams, for example, refers to a "trio" of factors -- demographics, productivity growth, and the global demand for safe assets.
  8. ^ Jerome H. Powell. 2018. "Monetary Policy in a Changing Economy", Jackson Hole Symposium, Wyoming, United States, 24 August.
  9. ^ Rachel McCririck and Daniel Rees, 'The Neutral Interest Rate', Bulletin, Reserve Bank of Australia, September quarter 2017.