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2024 Feb/19
Assessing the likelihood of a structural shift in interest rates (I): Economic structural change and the real neutral interest rate
Research Papers 24-04
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- Research Topic Macrofinance
- Page 61
- Summary
- Following the spread of COVID-19 and the steep rise in inflation, along with central banks in major countries raising interest rates, there is uncertainty about the future interest rate trend. There are contrasting views on whether we will return to the low-interest rates seen after the global financial crisis or if the long-standing trend of declining interest rates since the 1980s will be halted, resulting in a prolonged period of high interest rates. In this context, this report aims to provide the directional outlook for trend nominal interest rate fluctuations based on anticipated structural changes, such as demographic shifts, deglobalization, and productivity improvements.
Firstly, it has been statistically demonstrated that long-term government bond yields in South Korea and the United States maintain a stable relationship with the real neutral rate and trend inflation. Consequently, the factors influencing interest rates have been analyzed by distinguishing between the real neutral rate and trend inflation, leading to the creation of two research reports. This report, as the first part, primarily analyzes the impact of economic structural changes on the real neutral rate, summarizes and incorporates the outlook for trend inflation to be addressed in the second part, presenting the directional changes in trend interest rates and deriving policy implications.
To analyze the impact of economic structural variables such as demographic changes, productivity shifts, and national debt on the real neutral rate, forecasts for long-term real neutral rates in South Korea and the United States were estimated using UN population estimates, OECD productivity forecasts, and the National Assembly Budget Office's fiscal outlook. The analysis results suggest that the United States is expected to experience a rebound in the real neutral rate due to productivity improvements, while South Korea is forecasted to have a sustained plateau in the real neutral rate due to rapid population aging. Moreover, considering the results of the second part, which indicates a significant possibility of the end of the low inflation trend in South Korea and the U.S. due to future deglobalization and aging trends, it is concluded that global interest rates are likely to be stuck in a high-interest rate environment, and domestic interest rates are expected to find it challenging to return to the previous low-interest levels.
The directional trend of these interest rates poses challenges for fiscal policy in terms of the potential burden of interest costs due to expanding national debt and the possibility of fiscal expansion amid a household debt crisis. Regarding monetary policy, it raises challenges such as the central bank's dilemma in responding to supply shocks and the structural reversal of domestic and foreign interest rate differentials. Additionally, for the financial investment industry and pension funds, it suggests the need to consider changes in the relationship between asset yields and formulate new asset allocation strategies in response to market changes.