"Increased Safe Asset Supply Raised Long-Term Neutral Interest Rate"

2024 BOK International Conference
Session 3 on the 30th: Presentation on 'Determinants of Global Neutral Interest Rate'
Tiago Pereira, Group Manager at the US Federal Reserve Board

A study has found that the recent increase in the supply of global safe assets (U.S. Treasury bonds) has acted as a key factor in raising the long-term neutral interest rate. The neutral interest rate refers to the appropriate rate level at which economic growth can be achieved at the potential growth rate without overheating or recession.

Tiago Pereira, Group Manager of the U.S. Federal Reserve Board (Fed), attended as a presenter for Session 3 at the 'BOK International Conference' held on the 30th at the Bank of Korea annex in Jung-gu, Seoul, and presented on the topic of 'Determinants of the Global Neutral Interest Rate.'

In his paper, Manager Pereira stated that the increase in the global supply of safe assets after the financial crisis contributed to the rise in the neutral interest rate.

The paper considered factors determining the neutral interest rate, including each country's productivity trends, labor force proportion, global safe asset demand and supply, and the global spillover effects of changes in other countries' fundamentals. The global spillover effect refers to the impact of productivity trends or demographic changes in other countries on a country's own neutral interest rate.

Analyzing the determinants of the long-term neutral interest rate of 11 advanced countries from 1960 to 2019, the study found that the long-term neutral interest rates of major advanced countries showed a declining trend from the late 1990s until before the financial crisis, then slightly rebounded after the 2008 financial crisis.

The decline in the long-term neutral interest rate in the 2000s was attributed to productivity slowdown and negative spillover effects between countries. The increase in the supply of global safe assets significantly contributed to the rise in the neutral interest rate after the 2008 financial crisis.

On the other hand, the decrease in the labor force acted as a factor lowering the neutral interest rate after the financial crisis.

In the case of the United States, the productivity trend turned upward in the late 2010s, becoming a factor that raised the long-term neutral interest rate.

Manager Pereira said, “The long-term neutral interest rate is influenced not only by a country’s productivity trend and demographic structure but also by the supply and demand of global safe assets and the global spillover effects of changes in trading partners’ fundamentals.”

He added, “In particular, the supply of global safe assets has recently acted as an important determinant of the rise in the long-term neutral interest rate,” and evaluated that “this suggests that the cost of rising national debt may not be insignificant.”

He analyzed, “If the demand for safe assets expands in the future due to population aging, it is expected to act as a factor lowering the long-term neutral interest rate.”