There is no doubt that the ‘natural rate’ is probably lower today in many developed economies than it was just one or two decades ago, but TE makes no effort to describe the current settings of monetary policy in the dual contexts of global asset prices or the global monetary system. However, in the FX arena, we are all used to watching both.
If the real rate of return on asset prices in domestic or foreign currencies is above the ‘natural rate’ as a result of QEinduced capital flows, do estimates for the ‘natural rate’ become a less useful guide for how far monetary policy should go? Additionally, if financial institutions are raising their expected returns for global asset prices as QE continues, does this not reduce the ‘natural rate’ in a given economy as capital which might have been used for loan growth is deployed elsewhere? As Chart 1. below attempts to demonstrate, money velocity may be slowing as QE-induced capital flows lift global asset prices, meaning there is potentially a lower supply of money for loan growth from banks in domestic economies. Moreover, money velocity may not be weak simply due to the crisis, but also because debt burdens are already quite high by historical standards. Higher demand for a limited amount of high quality collateral in a global context may also be a factor which is depressing estimates for the ‘natural rate’ of interest in the developed world.
BMO