MNI INTERVIEW:Central Banks To Be Trapped by Neutral Rate Drop

The Fed, ECB and BOE may not escape the low-for-long world as weak investment and population growth this decade pull down the global neutral interest rate by 75 basis points, according to Adrien Auclert, a former BOE economist who has presented at over a dozen regional Fed conferences.

That means central banks around the world are unlikely to raise benchmark rates as high as they did before Covid, he told MNI. Policy makers will be pressured to refashion some extraordinary tools such as asset purchases as regular parts of the toolkit, and the Fed will likely have to reconsider negative rates in future crises, Auclert added.

"With r-star likely to keep falling so low and potentially negative we have to figure out tools to deal with this world and you have to have some monetary policy that goes with that," Auclert said.

Combining population forecasts with household survey data from 25 countries, Auclert and coauthors Hannes Malmberg, Frederic Martenet, and Matthew Rognlie in a recent paper predict population aging and falling investment will cause global neutral real interest rates around 0.5% pre-Covid to fall 75bps by 2030 and 123 bps overall through the end of the century.

LOWER FED RATE CYCLE

The Fed may be able to raise nominal interest rates as high as 2.25% at the peak of the business cycle after coronavirus, but there is a downward risk as population aging accelerates later this decade, Auclert said.

That's short of the 2.5% where FOMC officials see the policy rate peaking, based on looking at Fed estimates of r-star and forecasts in the Summary of Economic Projections. The Fed's view of the interest rate that balances the economy in the long run was slashed to a new low in June 2019 of 0.5% and has remained there through the pandemic.

The short-run neutral rate will also climb as the U.S. economy recovers, Auclert said, but still settle at a lower point than in the previous recovery from the financial crisis because of the drag from global demographics.

While some have suggested neutral interest rates are at risk of moving slightly higher temporarily on the back of productivity gains and trillions of dollars in Biden administration spending, many market analysts see a fall in the terminal fed funds rate below 2%, with some predicting a number as low as 1%. (See: MNI INTERVIEW: Fed Seen Trapped Near Zero After Biden Trillions)

POWELL'S DISINFLATIONARY VIEW

Auclert and coauthors agree more with Fed Chair Jerome Powell on the controversy around what an aging population means for inflation pressure, saying that slower price gains are coming. In his Jackson Hole speech last month, Chair Jerome Powell said his focus is on the prevalence of global disinflationary forces.

On that stand Auclert and Powell both challenge the hypothesis that Charles Goodhart, a former BOE economist, and Manoj Pradhan espouse that globalization and an aging population will cut down global savings and give rise to an inflationary period.

"While dissaving by the elderly will decrease net savings, declines in the population growth rate will cause net investment to go down as well. The latter effect will dominate causing interest rates to fall," said Auclert, a professor at Stanford University, currently a fellow at the University of Chicago.