Various economic forces would contribute to this outcome. On the one hand, the contraction would be associated with a persistent fall in the profitability of new investment. Expected returns on all investment opportunities would therefore tend to remain low. On the other hand, uncertainty would also tend to increase during the recession.
As a result, precautionary saving would also increase, exerting further downward pressure on the natural interest rate.4 Investment in new projects would also be discouraged in this situation of greater uncertainty.5 All in all, the demand for new borrowing in the economy would fall and, other things being equal, the excess supply of funds would exert further downward pressure on the real interest rate.