Understanding the changing equilibrium real interest rates in Asia-Pacific

BIS Working Papers No 567
June 2016

This paper studies the evolution of the equilibrium real interest rate (ie natural or neutral interest rate) in Asia-Pacific. I take an empirical approach to estimate the rate, simple estimates suggest that except for China, and Thailand since 2005, the natural interest rate may have declined substantially in Asian-Pacific economies since the early or mid-1990s, by over 4 percentage points on average. In many economies the rate has turned negative. The tendency has become more accentuated in the 2000s, especially since the onset of the global financial crisis. Yet simple natural interest rate estimates are unreliable, which vary significantly over time and across the economies.

I use frequency-domain techniques to examine the relationship between the long-run component of real interest rate and those of population characteristics, globalisation, and a range of macroeconomic and financial variables (eg credit and asset prices). I estimate spectral and cospectral densities, coherency and the frequency-specific coefficients of correlation and regression proposed by Zhu (2005). the association seems to be broad and strong between the natural interest rate and the low-frequency trend components of demographic and global factors in Asia- Pacific, but weak between the natural interest rate and trends in asset prices, creditto GDP ratio and trend growth in many economies in the region. In most cases, the natural interest rate seems to be correlated with broad measures of long-term financial sector development, and trends in saving rate and investment ratio.

JEL classification: E43, E44, E52, F62, J11

Keywords: asset price, credit, demography, equilibrium real interest rates, frequency-domain methods, globalisation, natural interest rates, population ageing, trend growth