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The value of any investment made in the funds or otherwise and the income from such can go down as well as up, and the investor may not get back the full amount invested. Past performance is not a guarantee of future returns. Changes in the rate of exchange may also cause the value of overseas investments to go up or down. Funds that invest in asset classes carrying greater risk, such as emerging markets, high yield securities and securities of small capitalisation companies may have a higher risk of loss of capital.

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Capital IdeasTM

Investment insights from Capital Group

Categories
Federal Reserve
Why R-star may rise, and its implications for rates and policy
Jared Franz
Economist
June 19, 2023

R-star is the real interest rate that is neither expansionary nor contractionary when the economy is at full employment. If the central bank sets its policy rate below R-star, then its monetary policy position is accommodative. The Fed currently believes R-star is about 0.5%, which is significantly lower than the Fed’s calculation of 2% a decade ago.


However, several factors are driving up this R-star value:


1. Demographic dynamics may be changing - the US and other developed nations are shifting from aging populations to old populations. As people age, they eventually save less, which is supportive of a higher R-star.


2. Government spending is expected to increase - a general rule of thumb is that a percentage point increase in federal debt to gross domestic product (GDP) can help push up R-star by three basis points. Over the past decade, US government debt held by the public has grown from 70% of GDP in 2012 to 97% in 2022, equating roughly to an 80 basis point increase in R-star.


3. Capital investment in factories, warehouses and supply chains will likely rise - The pandemic, US-China tensions and the Russia-Ukraine war have put a new emphasis on building reliable supply chains and ensuring national self-sufficiency. Companies are looking to shift operations closer to end markets or add redundancy. This could unleash a new wave of capital investment in physical infrastructure which should lead to a net upward pressure on real interest rates.


4. A productivity boost may be coming - the rise of generative AI such as ChatGPT may help lead to a recovery in labour productivity, which could also motivate corporate investment. And every dollar of investment would contribute to a higher R-star.


Jared Franz is an economist with 18 years of investment industry experience (as of 12/31/2023). He holds a PhD in economics from the University of Illinois at Chicago and a bachelor’s degree in mathematics from Northwestern University.

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Interest Rates
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