ECB Monetary Shifts: Tracking R-Star

Key arguments

• Euro area R-star is estimated at 2.2%, marginally below the ECB deposit rate of 2.5%, implying only a modestly restrictive policy stance.
• The prolonged low interest rate environment paradoxically depressed investment while boosting private sector saving in both the US and the euro area, challenging standard monetary transmission.
• Real interest rates and R-star are driven by the same global long-run forces: productivity growth, demographics, the global saving-investment balance and fiscal policy.
• Monetary policy decisions, transmission lags (12-18 months), financial frictions, excess liquidity and term premium suppression explain persistent wedges between observed real rates and R-star.
• Abundant central bank liquidity is likely to keep short- and long-term real rates below R-star in the near term, but rising sovereign debt concerns risk accelerating convergence via higher term premiums.
• Anticipated AI-driven productivity gains may lift R-star over the medium term, but the euro area's adverse demographic trajectory is likely to materially temper this impulse.
• Demand for risky assets is best seen as a symptom and amplifier of excess liquidity rather than an independent explanatory variable for the R-star/real rate gap.

Corresponding source evidence

1. This apparent paradox may reflect rigidities in required returns on capital and deleveraging pressures — weighing on investment — alongside precautionary saving motives, including fears of higher unemployment and the partial substitution of lost fixed-income returns, particularly in the euro area.
2. The sharp rebound in real interest rates since 2022 has rekindled debate among academics and policymakers over the nature of R-star — the inflation-adjusted rate consistent with full resource utilisation and inflation at target. · 2022
3. Our estimates find that R-star in the euro area is at 2.2% today, suggesting that the current ECB monetary policy stance ismoderately restrictive.