BPEA | Spring 2019

On falling neutral real rates, fiscal policy, and the risk of secular stagnation

A woman points to an electronic board showing stock prices as she poses in front of the board after the New Year opening ceremony at the Tokyo Stock Exchange (TSE), held to wish for the success of Japan's stock market, in Tokyo, Japan, January 4, 2019. REUTERS/Kim Kyung-Hoon - RC14906C3900
Editor's note:

This paper is part of the Spring 2019 edition of the Brookings Papers on Economic Activity, the leading conference series and journal in economics for timely, cutting-edge research about real-world policy issues. Research findings are presented in a clear and accessible style to maximize their impact on economic understanding and policymaking. The editors are Brookings Nonresident Senior Fellow and Northwestern University Professor of Economics Janice Eberly and Brookings Nonresident Senior Fellow and Harvard University Professor of Economics James Stock. Read summaries of all six papers from the journal here.


This paper demonstrates that neutral real interest rates would have declined by far more than what has been observed in the industrial world and would in all likelihood be significantly negative but for offsetting fiscal policies over the last generation. We start by arguing that neutral real interest rates are best estimated for the block of all industrial economies given capital mobility between them and relatively limited fluctuations in their collective current account. We show, using standard econometric procedures and looking at direct market indicators of prospective real rates, that neutral real interest rates have declined by at least 300 basis points over the last generation. We argue that these secular movements are in larger part a reflection of changes in saving and investment propensities rather than the safety and liquidity properties of Treasury instruments. We then point out that the movements in the neutral real rate reflect both developments in the private sector and in public policy. We highlight the levels of government debt, the extent of pay-as-you-go old age pensions and the insurance value of government health care programs have all ceteris paribus operated to raise neutral real rates. Using estimates drawn from the literature, as well as two general equilibrium models emphasizing respectively lifecycle heterogeneity and idiosyncratic risks, we suggest that the “private sector neutral real rate” may have declined by as much as 700 basis points since the 1970s. Our findings support the idea that, absent offsetting policies, mature industrial economies are prone to secular stagnation. This raises profound questions about stabilization policy going forward. Achievement of levels of deficits and government debt generally considered desirable – especially if complemented by reductions in social insurance – would likely mean negative neutral real rates in the industrial world. Policymakers going forward will need to engage in some combination of greater tolerance of budget deficits, unconventional monetary policies and structural measures to promote private investment and absorb private saving if full employment is to be maintained and inflation targets are to be hit.


Rachel, Lukasz and Lawrence H. Summers. 2019. “Public boost and private drag: government policy and the equilibrium real interest rate in advanced economies.” Brookings Papers on Economic Activity, Spring, 1-76.


Lukasz Rachel is a senior economist at the Bank of England and a PhD candidate at the London School of Economics. Lawrence Summers is the Charles W. Eliot Professor and President Emeritus at Harvard University. Beyond these affiliations, the authors did not receive financial support from any firm or person for this paper or from any firm or person with a financial or political interest in this paper. They are currently not officers, directors, or board members of any organization with an interest in this paper. No outside party had the right to review this paper before circulation. The views expressed in this paper are those of the authors, and do not necessarily reflect those of the Bank of England, the London School of Economics, or Harvard University.