In macroeconomics the equilibrium interest rate also known as the “natural rate of interest” is the rate of interest that would be determined in a free market economy if there was no inflation or deflation. The natural rate of interest is often thought of as the nominal interest rate that would be set by the central bank if the economy were operating at full employment.
The natural rate of interest is important because it is used to help determine the output level of an economy. If the natural rate of interest is high then businesses will want to invest more and consumers will want to save more. This will lead to a higher output. Conversely if the natural rate of interest is low then businesses will want to invest less and consumers will want to save less. This will lead to a lower output.
There are a number of different ways to measure the natural rate of interest. One common method is to look at the yield on government bonds. This is often seen as a good proxy for the natural rate of interest because government bonds are considered to be very safe investments.
Another common method is to look at the rate of return on a portfolio of investments that are considered to be “risk-free.” This portfolio would typically consist of things like government bonds and short-term treasury bills.
The equilibrium interest rate is not always easy to measure and there is often a considerable amount of debate about what the “right” level is. Nevertheless it is a important concept in macroeconomics and is used to help determine things like output and inflation.
What is the equilibrium interest rate?
The equilibrium interest rate is the interest rate at which there is no tendency for savers to either increase or decrease their level of saving.