Natural rate of interest

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Short-term interest rates in the euro area and the United States

Key Points:

Short-term interest rates in the euro area and the United States
Notes: Benchmark short-term nominal interest rate (panel A) and natural rate of return (panel B) for the euro area and the United States.
Low levels of the natural rate for protracted periods of time pose challenges for the conduct of conventional monetary policy.
This can happen because the ELB on nominal interest rates precludes the policy rate from tracking the natural rate if the latter falls below the bound.
In economies with low natural rates, such as the euro area today, macroprudential policy can have benefits for the effectiveness of conventional monetary policy, in addition to safeguarding financial stability.
The natural rate which is a risk-free, short-term real interest rate therefore increases as well.
The above benefit points to a novel complementarity between macroprudential policy and conventional monetary policy, which takes place only in environments with low interest rates.
If these conditions hold, macroprudential policy boosts the natural rate above the ELB, and it does so unintentionally, simply as a by-product of safeguarding financial stability.
That is, macroprudential policy still improves the effectiveness of conventional monetary policy, but it does not allow the policy rate to accommodate aggregate demand appropriately without hitting the ELB.
In economies with low natural rates, macroprudential policy can have benefits for the effectiveness of conventional monetary policy, in addition to safeguarding financial stability.
These benefits arise because macroprudential policy boosts the natural rate simply as a by-product of containing systemic risk in financial markets which gives the central bank more room for stimulating aggregate demand, especially during downturns.