It is amazing how things we once thought impossible, or at least extremely improbable, can become commonplace. Ten-year government bond yields in most of Europe and Japan are at or below zero. And, for U.S. Treasurys, the yield has been below 1 percent since March.

A confluence of factors has come together to deliver these incredibly low interest rates. Most importantly, inflation is far lower and much more stable than it was 30 years ago. Second, monetary policy remains extremely accommodative, with policy rates stuck around zero (or below!) for the past decade in Europe and Japan, and only temporarily higher in the United States. Third, the equilibrium (or natural) real interest rate (r*)—the rate consistent in the longer run with stable inflation and full employment—has fallen by roughly 2 percentage points since 2008 and is now only 0.5% or lower.

How long will this go on? What’s in store for r*? Focusing on the United States, in this post we discuss the large post-2007 decline in r* that followed a gradual downward trend in prior decades. After considering various possible explanations, we focus on the change in U.S. saving behavior. Around 2008, there was an abrupt increase in household savings relative to wealth and income. Combined with increased foreign demand for U.S. assets, this appears to be a key culprit behind the recent fall in r*.

We doubt that this will change anytime soon….