The IMF has signaled a guarded optimism about reaching pre-pandemic interest-rate levels, arguing that the recent rise in real rates could ease once inflation is firmly under control. The message is one of confidence: a return to healthier rate norms could stabilize the real estate markets in Spain and influence the broader policy debate in North America and beyond amid ongoing financial uncertainty. The IMF believes that real interest rates, which reflect the inflation-adjusted cost of borrowing, will move back toward pre-pandemic benchmarks as price pressures ease. Yet, the timeline for achieving this price stabilization remains uncertain.
The institution assesses the possibility that current increases in real interest rates may prove temporary and forecasts that central banks in advanced economies will allow real rates to ease when inflation ceases to threaten price stability. The IMF emphasizes that monetary policy should align with the pace of inflation, while governments face choices about fiscal stance. If authorities resist pressure to ease policy, they may need to pursue spending restraint or higher taxes, or a combination of both, as part of fiscal consolidation measures.
Looking ahead, IMF projections consider how demographic trends and productivity growth in large emerging economies could influence the path toward real-rate convergence. The Fund cautions that the adjustment back to pre-pandemic levels hinges on scenarios in which high public debt, persistent deficits, or financial fragmentation become more pronounced. The analysis suggests risks to the low-interest-rate floor and the potential for a prolonged period of subdued rates to reemerge. By actively managing central-bank balance sheets and using forward guidance, non-traditional tools could become standard stabilization instruments even in emerging markets. A notable international risk is the increasing fragmentation of foreign direct investment, with capital flowing more to geopolitically strategic economies. This could leave several emerging markets vulnerable to shifts in capital allocation and exchange-rate dynamics in the coming years.
Towards the natural rate of interest
The natural rate of interest—often described as the real rate that neither fuels nor contracts economic activity—serves as a crucial reference for both monetary and fiscal policy. It helps gauge the stance of monetary policy and plays a key role in assessing the sustainability of public debt. IMF analysis indicates that in advanced economies, interest rates may drift toward pre-pandemic levels once the current inflation surge subsides. The extent of convergence will depend on whether policy paths include higher debt burdens or fiscal fragmentation, or successfully avoid them.
Discussions among financial authorities about the appropriate inflation-targeting framework may reemerge as economists weigh the social costs of higher inflation against the constraints of stable policy when facing a persistently low effective lower bound. Conversely, a longer period of falling real rates could expand fiscal space, enabling authorities to take a more proactive role in stabilizing the economy if long-term fiscal sustainability is secured. In this context, IMF officials have stressed the importance of clearly delineating the roles of fiscal and monetary authorities to preserve central-bank credibility over time. A recent IMF briefing highlighted that well-designed fiscal policy can aid central banks in containing inflation while protecting the most vulnerable groups. As noted by Vitor Gaspar, the IMF’s Financial Affairs Director, coordinated policy can reduce the need for aggressive rate hikes while maintaining social safeguards. This perspective aligns with statements suggesting that less aggressive monetary tightening can accompany prudent fiscal adjustments to curb inflation.
The IMF asserts that while monetary policy leads the fight against inflation, fiscal policy can contribute through targeted adjustments that support price stability without harming vulnerable populations. This coordinated approach aims to minimize the social and economic costs associated with higher living expenses during periods of transition.