Over the last decades, real interest rates have been on a steady downward trajectory in the euro area and other advanced economies, largely reflecting a decline in the natural interest rate. The natural interest rate (r*) denotes the short-term real interest rate prevailing under stable macroeconomic conditions, in the absence of transitory shocks or nominal rigidities. While r* is an unobservable variable whose empirical estimation is sensitive to the methodology adopted, available estimates indicate that the natural interest rate has been falling in the euro area. It presently stands at levels close to 0% or even negative, which compares with estimates of around 2% at the beginning of this century (Chart 2.1 – Panel A). The declining path has been determined by structural factors, such as demographic developments and a slowdown in productivity and potential output (i.e. the value of the output that an economy would have produced if labour and capital had been employed at their maximum sustainable rates), but also by financial factors, which have become particularly relevant in the wake of the crises that emerged since the last strategy review (Brand, Bielecki and Penalver, 2018).

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