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R* star is a fun concept (and a fun but now sadly limited-edition T-shirt as well).
It is the theoretically “neutral” level of interest rates that doesn’t stimulate or contract the economy, so it’s both a silly construct of economists with physics envy and an influential framework to understand where rates are heading.
The Bank of England’s Ambrogio Cesa-Bianchi, Richard Harrison and Rana Sajedi have therefore tried to come up with an estimate for the global economy’s R*, and decompose it into its various components.
This matters because . . .
. . . Within a standard macroeconomic framework, secular movements in real interest rates are determined by the factors that drive the supply and demand for capital. Over the long run, when capital can move freely across countries, there exists a single interest rate that clears the global capital market. This global trend real interest rate, Global R*, acts as an anchor for domestic interest rates in open economies, so that estimates of Global R* are important inputs to longer-term structural analysis, including the design of policy frameworks. So studying the factors that drive global wealth and capital accumulation is crucial for understanding interest-rate trends around the world.
Their stab at this differs from previous attempts which mostly used different models to come up with more real time estimates. Instead, they wanted to look through shocks to see the longer term trend.
And as has been widely discussed for years now, they find that R* has been sloping down for decades and remains very low.
And here is what they reckon has been driving the secular slump: falling productivity and ageing demographics (zoomable version):
This is why the BoE’s economists are sceptical that R* really is rising, as some economists and investors now think.
There may be short-term factors that might be lifting it somewhat at the moment, but the big drivers — older, less productive work forces — are not changing, and therefore the long-term trend of falling R-stars is still intact.
Further reading:
– The fault in R-stars (FTAV)
Source: Economy - ft.com
