But the interest rate should also contribute to equilibrium in the market for real capital in the long run. To achieve this, the real interest rate must not over time deviate too much from the return on real capital. Substantial deviations can give rise to undesirable fluctuations in the markets for real capital that have no basis in economic fundamentals. In Norway, both short- and long-term real interest rates are at the moment at a low level, compared to the past few decades. This is also the case in many other countries. How large the deviations from the neutral and the equilibrium rates are, on the other hand, is less clear. Neither the neutral rate nor the equilibrium rate are variables that can be observed. Economic theory can contribute insight into the factors that determine the equilibrium rate, but attempts to quantify it based on theory yield an uncomfortably broad interval. An alternative is to use historical average interest rates on the basis of an assumption that actual real interest rates will vary around the equilibrium rate. This method also poses problems, however. 2  BIS Review 22/2006  Throughout the period 1870-2005, the average long-term real interest rate in Norway has remained close to the average in the UK and the US: Norway 2.2 per cent, the UK 2.0 per cent and the US 2.8 per cent. In all countries, fluctuations in real interest rates have been substantial in periods. The real interest rate has fallen markedly since the beginning of the 1990s.
There is an ongoing debate about the reasons for the decline in long-term real interest rates over the last few years. I will not elaborate on that debate here; it is a subject worthy of a seminar by itself. One particular possibility, pertaining to the discussion of the roles of the real interest rate, is that the fall in long-term interest rates may partly reflect market participants’ assessment that the neutral real interest rate has fallen. During a business cycle, it is the real interest rate’s deviation from the neutral real interest rate – the real interest rate gap – that indicates whether monetary policy is expansionary or contractionary. The neutral real interest rate is difficult to estimate and may change over time. Nevertheless, we have tried. On an uncertain basis we estimate that the neutral real interest rate for Norway may now be close to 2½ per cent, having come down approximately 1½ percentage points since the mid-1990s. Forecasts in the latest Inflation Report indicate that the short term real interest rate in Norway will be close to its neutral level in about four years. According to this, the real interest rate gap (the difference between the neutral rate and the actual rate) has been negative since 2004. There is evidence that monetary policy has had the desired impact both on the real economy and on inflation. Monetary policy at the present phase of the cycle Growth in the Norwegian economy has been high since summer 2003. The expansion has gradually broadened.