gold investment, silver investment

Precious metals investment terms A to Z

Natural Interest Rate

Natural interest rates often equal to the neutral interest rate in many investors’ minds, but this is a mistake as they are important differences between the two. The latter is treated as the real interest rates that is consistent with output reaching its potential and stable inflation, while the former is an interest rate that reflects the time preference of market participants and allocates resources among the temporally defined stages of production. In other words, it is an equilibrating interest rate consistent with intertemporal consumption preferences and production plans.

OK, it sounds smart, but what does it mean? Well, it is the ratio of the value assigned to satisfaction in the immediate future and the value assigned to satisfaction in remoter periods in the future. To simplify, people prefer to get $100 today than in one year, right? But, assuming no risk and inflation, they accept to lend $100 today in exchange for any sum higher than $105 in one year – in such an example, the natural interest rate is 5 percent.

Hence, while the neutral interest is thought to be an equilibrium rate used as benchmark by central banks in conducting their monetary policy, the natural interest rates is the interest rate that would naturally determine the interest rates on the unhampered market. Without the central banks which constantly manipulate the interest rates, the market interest rates would be in line with the natural interest rates, adjusted by risk premium and inflation premium.

Natural Interest Rate and Gold

What is the link between natural interest rate and gold? The relationship is important although not obvious. You see, when central banks intervene in the markets, following the imaginary neutral interest rate, they artificially lower the market interest rates below the level determined by the natural interest rates. According to the Austrian School, it triggers the business cycle. The idea is that artificially low interest rates send false signals to entrepreneurs about market participants’ time preferences. In consequence, they engage in wrong (too long) investment projects. For a while, there is a boom, but then the bust arrives.

Of course, there is one problem with the natural interest rate – it is not observable, as markets always add the inflation and risk premia. However, when the Fed lowered the federal funds rate to practically zero in the aftermath of the Great Recession (see the chart below), it’s hardly disputable that it was below the natural interest rates. And that can lead to problems in the future…

Chart 1: Federal funds rate from 1970 to 2019.

Natural Interest Rate and Gold Chart

And this is where gold enters the scene. The yellow metal thrives when economies are struggling. Gold is a good investment during recessions due to its role as a safe-haven asset. Indeed, gold gained during most of the several last recessions – in particular, it performed best in contractions accompanied by uncertainty and a weak U.S. dollar, high and accelerating inflation (remember the 1970s?) or low and declining real interest rates

We encourage you to learn more about the gold market – not only about not only about the link between natural interest rate and gold, but also how to successfully use gold as an investment and how to profitably trade it. Great way to start is to sign up for our gold newsletter today. It’s free and if you don’t like it, you can easily unsubscribe. Sign up today!

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