The concept of a neutral real interest rate is unworkable in an open economy

The neutral real interest rate is a widely used concept : it is the real interest rate that balances supply and demand in the long term when inflation is equal to expected inflation and the central bank’s inflation target. In the event of an exogenous fall in demand or an exogenous increase in the supply of goods and services, the neutral real interest rate increases. But there is a problem: i f there is high international capital mobility, then if domestic demand falls or the supply of goods and services increases in one country, that country has an external surplus and accumulates external assets; if domestic demand increases or the supply of goods and services falls, it has an external deficit and accumulates external debt: the neutral real interest rate does not change in either case. We look at the example of the United States. The US real interest rate is very low and yet the country has a savings shortfall, which has led to the accumulation of external debt and not to a rise in the neutral real interest rate. The concept of a neutral real interest rate is therefore unworkable in an open economy with high international capital mobility.