At the ASSA economics conference on Sunday, I attended a session on the equilibrium real (inflation adjusted) interest rate. This topic was being discussed in particular as a metric relating to sluggish U.S. economic growth since the Great Recession.
First, some presenters documented empirically that real interest rates since 1860 has had episodes, some of which lasted many decades, of very different behavior. Not only has the level changed significantly in both directions, but the volatility has changed over time. Of relevance for the current economy, it has recently been very low, oftentimes negative.
Some researchers discussed a variety of reasons why the real interest rate is so low, including the rate of time preference, fed policy, and other factors, but they did not mention the incremental productivity of equipment and structures. This is probably because it is not intuitive that the incremental productivity of a computer, forklift, or a warehouse has fallen dramatically over time.
In Macroeconomic theory we relate real interest rates to the incremental productivity of equipment and structures via a formula. However, when we go to the data, the latter is not observable. To obtain a measure of the real interest rate, we must go to financial markets data and subtract inflation from a bond rate. In thinking about a productive economy, a reasonable bond rate to deflate is the corporate bond rate.
Some researchers postulated the idea that the low real interest rate is the reason for the low performance of the US Economy. I prefer the idea, promulgated by John Taylor, John Williams, and others, that the low real interest rate has been caused by other factors, in particular, fiscal policy uncertainty and costly regulations. I worry that there is a wedge, partly policy driven, that has inserted itself between the after tax incremental productivity of equipment and structures, and the deflated corporate bond yield. Another way of saying this is that while equipment and structures are themselves roughly as productive as before, but the productivity net of these recently higher costs is lower because the costs have risen substantially.
With this idea, we see that there are other factors, fiscal policy uncertainty and regulations, that have caused both slow economic growth as well as historically low real interest rates. It is at least a possible that long-term trends in the regulatory environment have partly contributed to the long-term evolution of the real interest rates since the 1860s.