Low Interest Rates Could Be Over - The neutral rate of interest
It is the rate at which the demand and supply of savings is in equilibrium, leading to stable economic growth and inflation.
First described by Swedish economist Knut Wicksell a century ago, neutral can’t be directly observed. Instead, economists and policy makers infer it from the behavior of the economy.
If borrowing and spending are strong and inflation pressure rising, neutral must be above the current interest rate. If they are weak and inflation is receding, neutral must be lower.
Why the neutral rate might be rising
Economic growth is now running well above Fed estimates of its long-run “potential” rate of around 2%, suggesting interest rates at their current level of 5.25% and 5.5% simply aren’t very restrictive.
“Conceptually, if the economy is running above potential at 5.25% interest rates, then that suggests to me that the neutral rate might be higher than we’ve thought,” said Richmond Fed President Tom Barkin.
Wall Street Journal 20 August 2023
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