More neutral rate? The brilliance comes from the star of the Fed

BOSTON (Reuters) – In a speech last month, Federal Reserve Chairman Jerome Powell expressed doubts about the usefulness of some key economic measures that officials are relying on to guide US policy. interest rates in recent years.

Among these tools, the "neutral rate", known to economists as the "star-r", is an estimate of the key rate that will keep the economy on an equal footing. A new study released Friday by a team of global central bankers suggests that this could be a mistake as a policy guide because the neutral rate itself could be the result of decisions made by the Fed.

"In a sense, lower rates lead to lower rates," said Piti Disyatat, one of the newspaper's authors and research economist at the Bank of Thailand. If the Fed's policy decisions also affect the neutral rate, "its ability to act as a benchmark is undermined," he said.

The document was among those presented at an economic conference in Boston, ten years after the 2008 financial crisis ushered in an era of unprecedented zero and negative interest rates around the globe. They take into account some of the assumptions on which central banks have been based since the inflationary shock of the 1970s.

Powell, trying to define his approach to managing the Fed as the bank ponders how much it can push the current rate hike cycle, has shown some mistrust to be guided by concepts like the rate of neutral interest theoretical level of full employment.

The Fed's current rate hike cycle will bring it back to the lower end of the Fed's estimated neutral rate – between 2.5% and 3% – by the end of the year. This served as a benchmark for assessing whether the policy is strict or flexible and as the end point of the accommodative policies of the last decade.

With strong job growth, rising wages and inflation on the rise, the economy may overheat at least as much as it did during the period recession. An erroneous assessment of the neutral rate situation could make policies less stringent than the real economy justifies.

Powell himself, a non-economist, said the Fed should not be too dependent on variables that can not be measured directly and that can only be estimated with great uncertainty.

Others claim that the neutral rate, whatever its estimate, should increase, allowing higher rates in general.

The abandonment of the neutral rate focus could support the arguments of those who believe that the Fed should instead pay more attention to the financial markets, and in particular to the evolution of financial risks.

Among them, Boston Fed President Eric Rosengren.

In an article published Thursday evening, Rosengren said the Fed, together with state and local authorities, should be more prepared to fight the next recession, including possibly using more capital reserves for banks.

"We were lucky to be able to start out," said the policies put in place to fight the crisis.

But "if a recession were to occur, we would not be particularly well positioned," with a key rate still below two percent.

One of the arguments for higher rates is to prevent financial risks from accumulating and, in so doing, worsening the downturn because of lower debt and lower debt levels. .

Former Fed Vice President Roger Ferguson, currently chairman of the TIAA pension giant, said Powell understated the importance of the neutral rate, which was an important step in managing the Fed's current tightening.

At the very least, said Mr. Ferguson, this would prevent markets from becoming too firmly attached to where they think the central bank will end up.

As investors enter an era of rising rates, "the risk is that if the Fed anchors the market inadvertently on a particular number … It's at that moment that you're surprised," he said. declared.