MNI: Market Measures Of r* Steadier In Pandemic-ECB Economists

Financial market-based measures and surveys proved more reliable than macroeconomic models at estimating the neutral real rate of interest during the abrupt economic fluctuations of the pandemic, European Central Bank economists told MNI, adding that r-star is now at similar levels to pre-Covid times.

“Models that really rely on extracting r-star measures based on economic fluctuations, they will translate these fluctuations that we saw during the pandemic into fluctuations in r-star,” the head of the ECB's Strategy Issues Section Claus Brand told an MNI podcast in which he was accompanied by senior economists Noemie Lisack and Falk Mazelis.

In contrast, longer-term expectations for interest rates were more stable, he said, echoing the economists’ findings in a piece on the natural rate of interest in the ECB’s February economic bulletin.

The natural real rate of interest, which fell in the wake of the global financial crisis, recorded only a small uptick during the pandemic but has remained at a relatively low level, said the economists, whose comments refer to their own and not the ECB’s opinions. The median estimate published in their paper was near zero.

Their findings were similar to those of a recent San Francisco Federal Reserve working paper, which used market-based measures to determine that the real neutral rates of three major Latin American economies had also emerged from Covid with little change. (See MNI INTERVIEW: Latam Neutral Rates Stable Through Pandemic)

The euro area’s neutral rate has been partially depressed since the 2007-2008 global financial crisis, which eroded risk appetite and boosted requirements for collateral in financial markets and the financial system, Brand said. Emerging market reserve accumulation has also contributed to the decline in government bond yields, he said, together with lower productivity growth and aging of the global population. “Here the key drivers are savings in anticipation of longer retirement periods,” Brand added.

RANGE OF ESTIMATES

The economists’ analyses of estimates of the neutral rate varied by 125 basis points from those of Eurosystem colleagues and other sources, as a result of “statistical uncertainty of the estimation of specific measures but also due to model uncertainty,” said Lisack, who also worked for the Bank of England and the Bank of France.

“Our aim is to take this into account by having a range of measures rather than one specific individual estimate,” she said, noting that examining varying measures can be useful for looking at broader trends.

Each model for estimating r-star has its benefits and disadvantages, said Mazelis.