Economics in a picture
Estimates for the euro area natural interest rate point to a decline since the 1970’s, standing at around 0.5% in 2022
The concept of natural interest rate, defined as the real interest rate that neither stimulates nor reduces economic activity or inflation, is particularly useful for monetary policy. The difference between the real interest rate observed in the economy and the natural interest rate — the real interest rate gap — allows an assessment on how more restrictive or more accommodative monetary policy is. At the same time, the natural interest rate can be seen as the level to which interest rates should converge over time.
Despite the uncertainty associated with the results, the estimates suggest that the natural interest rate in the euro area is on a downward trend, having gone from around 3% in the early 1970s to values around 0.5% in 2022.
The use of the natural interest rate in monetary policy communication can play a crucial role in ensuring that interest rate expectations in the longer term are consistent with a return of inflation to its target.
For more details, see Carvalho (2023): “The euro area natural interest rate – Estimation and importance for monetary policy”, Banco de Portugal Economic Studies, Vol. IX, No. 3, pp. 3-24.
Prepared by Alexandre Carvalho. The analyses, opinions and findings expressed above represent the views of the author and not necessarily those of Banco de Portugal or the Eurosystem.
If you want to receive an e-mail whenever a new “Economics in a picture” is published send your request to email@example.com.