Drifting Equilibrium Rates and Codrifting Yields in the Euro Area

Andrea Zito
Jan 5
2 min read

Updated: Jan 6

For years, interest rates in Europe and other advanced economies kept falling, puzzling savers and investors alike. Then, after 2022, rates surged at the fastest pace in decades. This report by the Bocconi Students Asset Management Club tackles a key question behind these movements: is there really a fixed “normal” level for interest rates, or does that benchmark itself change over time?

The central idea of the report is that the so-called neutral or equilibrium interest rate is not constant. Instead, it slowly drifts with long-term forces such as productivity growth, population ageing, and inflation expectations. When productivity slows and societies age, savings rise relative to investment, pushing equilibrium rates down. This helps explain why interest rates declined steadily from the 1990s to the late 2010s and why central banks were able to keep policy rates extremely low—sometimes even negative—without triggering inflation.

Building on this intuition, the authors show that central banks implicitly react to this drifting benchmark. Policy rates are better explained when they are allowed to move around a changing equilibrium rate rather than a fixed one. The same logic extends to bond markets: short-, medium-, and long-term government bond yields all tend to move together with this long-run equilibrium trend. In fact, most of the movement in bond yields reflects slow structural changes, while only a smaller portion is due to short-term shocks, risk sentiment, or policy surprises.

A key takeaway for investors and policymakers is that not every rise or fall in yields signals a change in market risk or central bank credibility. Much of it reflects deeper economic fundamentals that evolve gradually. Once these long-term trends are stripped out, the remaining “cyclical” movements in yields become more informative about short-term opportunities and future bond returns. Overall, the report offers a clearer framework for understanding today’s higher-rate environment—not as a simple return to the past, but as the outcome of shifting structural forces beneath the surface of monetary policy and financial markets.