Higher neutral, or just lags? At issue is the neutral rate of interest


Labor costs rise at fastest pace in year and a half

Rose 1.2% in the first quarter, and exceeded the 1% forecast of economists polled by The Wall Street Journal.

Wages and benefits rose 4.2% 

The Fed wants to see the annual increase in compensation slow to pre-pandemic levels of less than 3% a year to keep inflation down. 

MarketWatch 30 April 2024

https://www.marketwatch.com/story/employee-costs-rise-at-fastest-pace-in-a-year-and-a-half-1a89ae02


Interest-rate futures suggest the fed-funds rate will stabilize around 4% in coming years.

The persistence of strong demand doesn’t necessarily mean neutral has risen; it may simply mean higher rates have yet to work their way through the financial system. Households and businesses, having locked in their borrowing at low rates, may be relatively insulated from the recent rise in rates. 

Even If the Fed Cuts, the Days of Ultralow Rates Are Over

Another important argument is unfolding: where do rates settle in the long run?

At issue is the neutral rate of interest: 

the rate that keeps the demand and supply of savings in equilibrium, leading to stable economic growth and inflation.

For the last 40 years, and especially following the 2008 financial crisis, economists and Fed policymakers steadily revised down their estimates of neutral. 

This view became embedded in bond yields, mortgage rates, equity prices and countless other assets.

When the Fed raised the fed-funds rates to 5.3% last year, the highest since 2001, the economy appeared to shrug it off, giving reason to think neutral might be higher. 

The debate over r-star may have little near-term effect on the Fed because current interest rates are above virtually all estimates of neutral.

Dallas Fed President Lorie Logan warned in a recent speech that interest rates may not be as restrictive as believed because of a higher neutral rate.

Investors have already concluded interest rates aren’t likely to return to the low levels that prevailed before the pandemic. 

Interest-rate futures suggest the fed-funds rate will stabilize around 4% in coming years.

Nick Timiraos Wall Street Journal 28 April 2024

https://www.wsj.com/economy/central-banking/why-high-interest-rates-could-be-here-for-the-long-run-c6670448


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