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We must confess: FT Alphaville’s fondness for writing about R* stems from the pun potential. Its impact, much like R* itself, can be gauged “by its works”.
— Longevity killed the R-star
— R-star rises again
— R Star Star Wars: The Phantom Menace
— The fault in R-stars
— R* Wars — A New Hope?
— When you wish upon R*
— Feel the farce with your very own R-Star Wars memorabilia
etc etc…
If you’ve been fortunate enough to avoid the discussion about the graviton particle of economics, R* — or R-star — represents the “neutral” level of interest rates that neither stimulates nor contracts the economy, maintaining equilibrium between unemployment and inflation.
R* is a popular concept due to its practical importance — the ongoing query of whether current monetary policy is too loose or too tight is a perennial one for central bankers and investors — yet it remains entirely theoretical. The mathematically appealing approach to an economic concept attracts economists who may have wished they pursued physics.
Recently, economists at the Bank of England attempted a global R* estimation, suggesting it remains close to zero in real terms due to aging demographics and sluggish productivity growth. However, Goldman Sachs’ Kevin Daly offers a contrasting view.
Using market prices, specifically 3-year forward 1-year rates, Daly devised R* estimates for 12 developed and 24 emerging economies, adjusting them with inflation forecasts to determine a rough neutral real rate.
While Daly acknowledges the simplicity of his methodology, it allows Goldman Sachs to generate numerous estimates, observe variations over time, and analyze influencing factors.
His key findings are:
— Changes in US/global r* have predominantly driven developments in EM and DM neutral real rates over the past 25 years, impacting other economies almost equally. Country-specific spreads have largely remained stable in general, decreasing in some economies while increasing in others.
— In the most recent five-year period (2020-24), the neutral real rate spread compared to the US ranged from negative in certain DM economies (such as Japan, the Euro area, and Switzerland) to over 10pp in some high-yield EM economies with significant currency depreciation (like Turkey and Egypt).
— The majority of cross-country variation in neutral real rates is attributed to three factors: GDP per capita levels, inflation, and current account balances (more significant for EMs than DMs). A 10pp GDP per capita convergence lowers neutral real rates (r*) by 12bp, a 1pp inflation increase raises r* by 33bp, and a 1pp current account balance improvement reduces r* by 7bp (20bp in EM economies). Other factors like GDP growth, government balances, and debt levels show no independent impact.
— The results indicate high returns from macroeconomic stabilization. Economic convergence, lower inflation, and improved external balances offer a clear path to sustainably lower interest rates.
The dominance of US conditions in international R* measures, despite varying economic circumstances, is both expected and somewhat disheartening.
Goldman Sachs has released the full report for public access, available for reading at your convenience. Share your thoughts in the comments below.