A ‘New Normal’ for Rates? Not So Fast, Says New Fed Research
Summary
- ‘There is no evidence that the era of very low natural rates of interest has ended,’ says New York Fed President John Williams
A top Federal Reserve official presented research Friday showing the Covid-19 pandemic didn’t change estimates of a “neutral" interest rate that neither stimulates nor restricts demand, a finding with important implications for how high officials may raise rates to slow the economy.
Between the 2008 financial crisis and the 2020 pandemic, Fed officials and economists had concluded the neutral rate of interest, or the level that balances supply and demand when the economy is operating at full strength, had declined sharply. That, together with weak growth following the crisis, ushered in a period of historically low interest rates.
The Fed has raised its benchmark federal-funds rate aggressively over the past year to combat high inflation, most recently to a range between 5% and 5.25% this month.
Federal Reserve Bank of New York President John Williams said during a research conference hosted by the central bank that a widely followed model used to estimate the inflation-adjusted neutral rate of interest showed “there is no evidence that the era of very low natural rates of interest has ended."
If estimates of the neutral rate of interest shifted higher, officials could conclude that the rates needed to slow inflation would be considerably higher. If those estimates haven’t changed, then the fed-funds rate might be expected to return to less than 3% if the Fed succeeds in bringing inflation down to its 2% target over the next few years.
The model shows the inflation-adjusted neutral rate stood around 0.7% at the end of last year and has declined over the past year, though the degree of uncertainty over those estimates is large. Inflation was 4.2% in March, using the Fed’s preferred gauge, the personal-consumption expenditures price index. That would suggest a nominal neutral rate that is below 5%.
Fed Chair Jerome Powell is set to speak at the conference later Friday morning as officials weigh whether to continue raising rates at their policy meeting next month.
Write to Nick Timiraos at Nick.Timiraos@wsj.com
