Insight Investment

We have brought together Insight’s Global Macro Research team and BNY Mellon’s Economics team to provide their thoughts on the outlook for the neutral level of interest rates – this is the level of real interest rates at which central bank policy is neither stimulating or restricting growth. In our view the key factors that will influence the level of neutral rates in the years ahead are:

• Deglobalisation: After being one of the most important sources of disinflation for decades, globalisation is in the process of reversing. Both teams agree that this is likely to exert clear upward pressure on the neutral rate.
• Productivity and artificial intelligence: Productivity has materially slowed over recent decades, but some believe that artificial intelligence could result in a new productivity boom. This is an area where the views of the two teams diverge to the largest degree. The BNY Mellon team are optimistic about the potential for this new technology to boost productivity, and believe this could put significant upward pressure on the neutral rate, but the Insight team is more pessimistic about the benefits and cautious on the timescales.
• Demographics: The impact from demographic decline is complex and unclear. As growth in working-age populations slows, so does potential growth, exerting downward pressure on the neutral rate, but a shortage of labour can result in higher wages and investment, exerting upward pressure on the neutral rate. The interplay between these two factors is key and can vary between economies – both teams take a slightly different view on which is more important.
• Long-term economic growth and volatility: Slower, more volatile and negatively skewed growth results in greater demand for safe assets, exerting clear downward pressure on the neutral rate. But, if inflation is also volatile, an increase in risk premia can push the neutral rate upwards. The Insight team would put more emphasis on inflation volatility than on growth volatility and believe this could put more upward pressure on the neutral rate relative to the BNY Mellon team’s view.
• Climate investment: The impact of climate investment is hard to quantify, and the effect on the neutral rate is unclear. A difference of opinion on how this investment will have to be funded means the Insight team believe there will be more upward pressure on the neutral rate from this factor than the BNY Mellon team.