Low productivity growth is not driving persistently negative real interest rates, says Cleveland Fed economist

Historically, negative real interest rates have been associated with high levels of inflation and efforts by the Federal Reserve to reduce high unemployment rates. While inflation has been low since December 2008 and the unemployment rate has returned to low levels, negative real interest rates persist. A slowdown in long–run productivity growth is one popular explanation for negative real interest rates, as textbook macroeconomic theory predicts a positive relationship between productivity and real interest rates (implying that a lower trend in productivity growth will lead to persistently lower real interest rates).

However, Federal Reserve Bank of Cleveland economist Kurt Lunsford finds that the long–run correlation between real interest rates and productivity growth is actually negative from 1914 to 2016. That is, contrary to what standard economic theory would predict, low real interest rates have been historically associated with high productivity growth.

Because the two world wars and the Great Depression dominate the early part of Lunsford’s sample, he also examines the long–run correlation of real interest rates and productivity growth from 1948 to 2016. “Over this sample, different measures of the correlation give both positive and negative results. However, the measures are generally small in magnitude and statistically indistinguishable from zero. This suggests that factors other than productivity growth are important for understanding the long–run movements in real interest rates,” says Lunsford.

Lunsford says his results also:

• indicate that an upward shift in productivity growth will not necessarily lead to higher real interest rates
• suggest low productivity growth does not condemn the economy to low or negative real interest rates
• provide guidance for future research about the natural rate of interest, or r*, which is the level of the real interest rate that produces stable inflation.

Read Productivity Growth and Real Interest Rates in the Long Run

Federal Reserve Bank of Cleveland

The Federal Reserve Bank of Cleveland is one of 12 regional Reserve Banks that along with the Board of Governors in Washington DC comprise the Federal Reserve System. Part of the US central bank, the Cleveland Fed participates in the formulation of our nation’s monetary policy, supervises banking organizations, provides payment and other services to financial institutions and to the US Treasury, and performs many activities that support Federal Reserve operations System-wide. In addition, the Bank supports the well-being of communities across the Fourth Federal Reserve District through a wide array of research, outreach, and educational activities.

The Cleveland Fed, with branches in Cincinnati and Pittsburgh, serves an area that comprises Ohio, western Pennsylvania, eastern Kentucky, and the northern panhandle of West Virginia.

Media contact

Doug Campbell, doug.campbell@clev.frb.org, 513.218.1892