Rosanna Costa: Medium - and long-run trends in interest rates -
causes and implications for monetary policy
Opening remarks by Ms Rosanna Costa, Governor of the Central Bank of Chile, at the
XXVII Annual Conference of the Central Bank of Chile, Santiago de Chile, 4 November
2024.
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1. Welcome Remarks
Good morning to all the speakers, discussants, the organizers of this event, Atif Mian,
Sofia Bauducco, Mariana García and Lucciano Villacorta, and everyone who is here
attending in person and to those following us via streaming. We welcome you to the
twenty-seventh Annual Conference of the Central Bank of Chile entitled "Medium- and
Long-Run Trends in Interest Rates: Causes and Implications for Monetary Policy."
Since 1997, the Central Bank of Chile (BCCh) has been convening prominent scholars
and policymakers to this Conference to discuss major issues in central banking and
their implications for emerging economies. Since its inception, this Conference has
served as a bridge between academics and policymakers. This version is no exception:
fresh and thoughtful research will support the discussion over the next two days on a
topic that is very much front and center on the policy agenda. We will enjoy the
presentations of seven authors, seven discussants, two keynote speakers, and a policy
panel.
2. Motivation and context
This year's conference tackles a topic that is increasingly at the forefront of economic
discussions: the future trajectory of long-run real interest rates, their potential
determinants, and the implications for monetary policy. The timing of this topic couldn't
be more relevant, especially in light of the sharpest and most synchronized monetary
tightening we have seen in decades.
As we all know, central banks in advanced economies have recently started lowering
their policy rates and in many emerging economies this normalization process has been
under way for some time now. Even so, policy rates had risen significantly over the past
two years from their record lows in decades. This shift has sparked a lively debate
regarding the future of medium- and long-run trends in the real rates; specifically,
whether policy rates will revert to their pre-pandemic lows or will settle at a higher level.
Opinions on this matter vary widely among experts and I think there is not a clear
consensus on what the long run interest rates will look like in the future. On the one
hand, there are reasons to believe that real interest rates are likely to revert to their
historical lows, as the key factors that were mainly thought to have driven these rates
down over the past forty years-such as demographic shifts, stagnant productivity
growth, increased market power, higher risk aversion and sustained demand for safe
assets-do not seem likely to revert sufficiently to produce a significant and lasting
increase in real interest rates in the coming years.
On the other hand, recent market indicators suggest that equilibrium long-term real
interest rates have risen. Also, some new estimates of the natural interest rate-defined
as the "long-run" equilibrium rate after shocks have dissipated-indicates that this rate
may have risen in several advanced countries in the past few years. As I will discuss in
a while, this shift could indicate that at least some structural drivers of real interest rates
have changed direction or that the natural interest rate is adjusting to a new economic
environment possibly characterized by higher levels of public debt.
The future evolution of the natural interest rate has significant implications for monetary
policy. Accurately assessing the long-run trend of the natural rate is essential for central
banks, as this rate serves as a crucial reference point for monetary policy. The
difference between the real interest rate and the natural rate provides valuable insight
into a central bank's monetary stance and aids in evaluating various policy options.
However, the natural rate is an abstract concept, and its estimates often carry
considerable uncertainty, particularly in the post-pandemic period. Since the natural
rate is not directly observable, understanding its determinants has become vital for
effective monetary policy. I am confident that the fruitful discussions we will have during
this conference will deepen our understanding of these determinants and clarify where
natural rates and other relevant interest rates may stand in the years ahead.
In these opening remarks, I would like to take a moment to briefly review the key
empirical long run trends we have observed in interest rates, as well as the primary
explanations put forth in the literature. Following that, I will walk you through the main
agenda of the Conference.
3. Drivers behind the trends in interest rates
Over the past forty years (up to the Covid-19 pandemic in 2020-2021), we have seen a
remarkable decline in nominal interest rates across the globe. For example, during the
1981 to 2020 period, nominal returns on U.S. Treasury bonds, both short and long term,
dropped significantly. The 2-year Treasury Bills experienced a drop of around 14
percentage points, and 10-year bonds saw a decline of 13 percentage points. During
this same period, inflation also fell, albeit to a lesser degree, leading to real rate
declines of about 5 and 4 percentage points for the 2- and 10-year bonds, respectively,
putting sovereign real interest rates close to zero and even in negative territory for
some periods. The decline was not limited to sovereign bond rates; it was also present
in the returns on other so-called "safe" assets. Importantly, this downward trend was not
exclusive to the United States. Real long-term rates have declined by several
percentage points since the early 1980s in both developed and emerging economies,
so this appears to be a global phenomenon.
The global downward trend in observed risk-free rates over an extended period
suggests a significant decline in the natural interest rate, often referred to as the
"longrun" equilibrium rate. This secular decline has coincided with a relatively stable
trajectory in the marginal product of capital, a stable trajectory on the returns on risky
assets, and a stable trajectory in the investment rate, particularly in advanced
economies. As a result, these patterns are often attributed to factors that have
increased the overall supply of savings over the years, alongside factors that have
redirected this excess in savings toward the demand for safe assets rather than
productive investments.
In recent years, much of the literature has centered on the hypothesis of a "global
saving glut." This theory suggests that a significant excess of savings from certain
countries and affluent groups has led to a marked shift toward safe assets.
Consequently, there has been a notable increase in the prices of these assets,
accompanied by a decline in interest rates.
One contributor to this phenomenon was the increased savings from emerging
economies, particularly since the 1990s. Factors such as robust economic growth,
soaring commodity prices, and high risk aversion all fueled greater savings in these
regions. As a result, these economies channeled substantial portions of their savings
into global markets, with a significant impact on interest rates in developed countries.
Another contributor to this saving glut was the increasing savings rates among the
wealthiest households in developed nations. As income inequality has risen, rich
households have saved a larger share of their income, further contributing to the excess
savings phenomenon. Research indicates that the savings of the top 1% in the United
States is comparable to the savings generated by the excess from emerging markets, a
trend the literature refersto as the "saving glut of the rich." This dynamic has profound
implications for wealth distribution and economic stability.
Other mentioned explanations for the excess savings are linked to more structural
factors, such as the secular stagnation hypothesis, which suggests a persistent decline
in potential economic growth that limits investment opportunities, thereby driving
savings toward safer assets. Additionally, demographic changes-including declining
population growth and longer life expectancy-have influenced savings behavior across
generations and regions.
Finally, rising risk aversion, the declining cost of investment goods, and the substantial
increase in corporate power over recent years further explain why this increase in
savings has been directed toward safe assets rather than productive investments.
Over the past 40 years, all these factors have shaped the dynamics of savings,
investment, and, consequently, interest rates, each contributing with varying
significance during different phases. Looking ahead, the trajectory of interest rates will
heavily depend on the uncertain evolution of these drivers.
The outlook for these structural factors influencing real interest rates is mixed. On the
one hand, several key factors behind the pre-pandemic decline in interest rates- such
as low potential growth, rising inequality, increasing uncertainty, growing market power,
and longer life expectancy- show no significant signs of changing direction. These
forces suggest that real interest rates may revert to their declining pre-pandemic trend.
On the other hand, additional factors could lead to a sustained rise in rates. These
include a decrease in savings due to a growing inactive population, substantial fiscal
deficits resulting in very high levels of debt, potential productivity gains from
advancements in artificial intelligence, geopolitical risks and climate disasters affecting
global savings, and significant investments in the green transition.
I hope our upcoming discussion will help clarify the direction of these drivers and
enhance our understanding of where the natural interest rate may be headed in the
future.
4. Conference contents
Let me now give a very brief overview of what we will be hearing today and tomorrow:
The Conference will start with the session "Interest Rates and Macroeconomic Policy"
In this session, the paper by Francesco Bianchi, Renato Faccini and Leonardo Melosi
examines the role of fiscal policy in shaping the future path of real interest rates. Then,
the paper by Gabriel Jiménez, Dmitry Kuvshinov, José-Luis Peydró and Bjorn Richter
will look at the links between the path of the monetary policy rate over time and the risk
of banking crises from a historical perspective.
Then, we will continue with the first keynote speech, delivered by Ricardo Reis. He will
address the implications of interest rate trends on inflation, as well as the subsequent
effects of inflation on these trends.
We will then transition to our second academic session, which will focus on "Theories of
Natural Interest Rates." The natural interest rate, an abstract concept, is defined as the
interest rate that prevails in long-term equilibrium once economic shocks have
dissipated and prices are fully flexible. As a latent variable, understanding its
determinants and refining its measurement is of paramount importance.
This session will begin with a paper by Ozge Akinci, Gianluca Beningno, Marco del
Negro, and Albert Queralto, who propose a complementary concept referred to as the
Financial (In) Stability Real Interest Rate. While the natural interest rate is typically
associated with macroeconomic stability, this new concept emphasizes the critical
importance of financial stability. Following this presentation, Galo Nuño will discuss
three theories concerning natural interest rates. Traditional theories often highlight
structural drivers such as technological advancement and demographic changes.
However, Galo's paper will challenge this conventional view, exploring how factors such
as public debt, household inequality, the zero lower bound, and persistent negative
supply shocks may influence natural interest rates.
To conclude this session, we will hear from Elías Albagli, Sofia Bauducco, Guillermo
Carlomagno, Luis Gonzales, and Juan Marcos Wlasiuk, who will discuss the potential
impacts of climate change and escalating geopolitical tensions on long-term interest
rates.
The second day will begin with the keynote speech titled "Long-Run Interest Rates:
Past, Present, and Future" by Atif Mian. He will explore the interconnections between
interest rates and both private and public debt over time. Atif will first address the role of
inequality in explaining the simultaneous decline in interest rates and the rise in debt
over the past few decades. He will then examine the dynamics of debt, discussing an
appropriate constraint on interest rates to prevent explosive borrowing. Finally, he will
focus on estimating future yields.
Next, we will transition to the session titled "Interest Rates, Inflation, and Transmission
to Emerging Markets." This session will open with the paper "U.S. Anti-Inflationary
Policy and Emerging Economies: 1980 vs. 2020s" by Drishan Banerjee, Galina Hale,
and Harrison Shieh. Their paper analyzes macroeconomic data from advanced and
emerging economies in the 1980s and 2020s to highlight differences in how U.S.
monetary policies have impacted emerging markets in these two distinct periods. The
second paper in this session, by Francisco Legaspe and Liliana Varela, will show how
country-specific risks, such as political uncertainty and risk on debt repayment explain
excess returns from investing in local currency assets in LATAM countries. Finally, a
policy panel featuring Elias Albagli, Jean-Marc Natal, Boris Hofmann, and Ricardo Reis
will offer insights into the future of interest rates and their implications for monetary
policy in emerging economies.
5. Acknowledgements
I would like to especially thank Atif Mian for being the external organizer of this
Conference, as well as locals Sofia Bauducco, Mariana García and Lucciano Villacorta
for putting togethersuch a wonderful program. I also thank all the speakers and
contributors and look forward to the Conference volume that we will publish in some
months with its formatted contents.
Let me finish by thanking María José Reyes, Constanza Martinelli, Carolina Besa,
Daniela Gaete, Daphne Guiloff, Pablo Barros, and both the Public Affairs Department
and the Economic Research Department of the Central Bank of Chile for all their
invaluable help managing the logistics of organizing this Annual Conference.
I wish you a fruitful discussion over the next two days.
Thank you.