A National Balance Sheet Approach to the Natural Rate of Interest

Abstract

We present a new estimation method for the “natural” interest rate and estimate its value for the US economy from 1961 to 2020. Presuming theoretical balance between returns on national assets and cost of national capital, we use US balance sheet information to derive a “breakeven” or implicit fundamental risk-free rate. Because, unlike r-star (r*), our rate does not presume conditions of full employment, its value should generally be lower than that of r*. We find, however, that our rate has remained above r* for much of the past 25 years, suggesting that the Federal Reserve’s accommodative policy for the past two decades has been more aggressive than previously believed. Understanding the difference between our natural rate, r*, and current market rates is critical for proper decisions in the fixed income markets.