What, exactly, is “neutral” in the post-pandemic economy?

The Next Big Fed Debate: Has the Era of Very Low Rates Ended?

Fed officials trying to figure out just-right interest rate and some think they might be close to that destination

Powell has described recent rate reductions as an effort to recalibrate borrowing costs to a more “neutral” setting. 

His framing raises a question that hasn’t been relevant until now: What, exactly, is “neutral” in the post-pandemic economy?

The neutral rate of interest, or the rate that keeps the economy at full employment with stable inflation, can’t be directly observed.

Instead, economists and policymakers infer it from the behavior of the economy. If borrowing and spending are strong and price pressures are rising, the current interest rate must be below neutral.

If they are weak and inflation is receding, rates must be above neutral.

Every quarter, Fed officials project where rates will settle over the longer run, which is in effect their estimate of neutral. 

The median estimate declined from 4.25% in 2012 to 2.5% in 2019. 

It stayed at that level through 2023 but has steadily crept higher in all four quarterly projections this year—to 3% in those released Wednesday.

Powell has long been dismissive of using overly precise estimates of the neutral rate to set policy. 

The upshot is that even if the neutral rate has gone up, “we won’t have clear, strong evidence of that”

in time to set policy accordingly, said Jon Faust, who served as a senior adviser to Powell from 2018 until June.

Nick Timiraos Wall Street Journal 18 December 2024

https://www.wsj.com/economy/central-banking/federal-reserve-interest-rates-2025-557b047e

Fed as Clueless as Markets

When the stewards of monetary policy are so uncertain, the best course of action is to do nothing.

Some members of the Fed’s rate-setting committee have argued that the world has fundamentally changed in recent years, and that policy rates as they stand today may actually be close to the “neutral” rate — the setting that’s neither stimulative nor restrictive but just right. 

As Powell said Wednesday, “we’re significantly closer to neutral” but also “still meaningfully restrictive” — whatever that word salad means.

Jonathan Levin Bloomberg 18 December 2024

https://www.bloomberg.com/opinion/articles/2024-12-18/the-fed-is-as-clueless-as-markets

Tillbaka till Rolfs länktips 19 december 2024

https://englundmacro.blogspot.com/2024/12/rolfs-lanktips-19-december-2024.html