Brookings Podcast on Economic Activity Is the neutral rate of interest going to start climbing after years of decline?
Dec 4, 2025
Lukasz Rachel, an Assistant Professor at University College London and author on the natural rate of interest, dives into the significance of the neutral rate of interest, or r*. He traces r*'s decline from the 1970s and discusses how demographics and slower growth have contributed to this trend. Rachel outlines six potential scenarios, including the impact of AI, that could reverse the decline, potentially raising r* again. The conversation reveals essential implications for policymakers and the broader economy.
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What R-Star Actually Is
- R-star anchors the long-run real interest rate that would prevail with full employment and stable inflation.
- It matters for monetary stance, fiscal financing costs, and household and firm decisions.
The Big Decline In R-Star
- R-star fell from about 5% in the 1970s to near zero today in real terms, driven by saving-investment imbalances.
- Key drivers include demographics, lower productivity and population growth, and increased precautionary saving.
Demographics And Growth Lower Rates
- Demographics strongly raised saving needs as expected retirement lengths jumped from ~7 to over 20 years.
- Slower productivity and population growth reduced investment demand, lowering the equilibrium interest rate.