Re-visiting R*

What central banks can do is to set a policy rate that is comparable with what the Swedish economist Knut Wicksell called a natural interest rate, R*.

We can understand the state of monetary policy by looking at the key policy rate relative to R*.   The problem of course is that we cannot observe R* directly, but we can try to estimate R* from the historical relationship between macroeconomic variables and the policy rate.

It is probably reasonable to assume that the Fed eventually will get it right – and bring inflation down towards 2%, while keeping unemployment close to its structural level (NAIRU). 

If we use this as input in out R* we can simulate a scenario for the Fed funds rate in the coming years.

Tlhe Market Monetarist 30 January  2023


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