Everyone is struggling to see where interest rates are headed. Investors are jittery, as shown by gyrating long-term Treasury yields. America’s central bankers are trying to project calm, but they are in a fog too. On August 25, Federal Reserve chair Jay Powell summarised the mood when he said “we are navigating by the stars under cloudy skies”. Economists do have some tools to illuminate the path ahead. But they aren’t very helpful.
The object everyone is searching for is the neutral rate of interest, or R-star for short. (Economists seem to struggle with nicknames.) It is the (real) rate that neither buoys nor depresses the economy once temporary shocks have faded away. Central bankers believe that they can neither influence it nor observe it. Their task is merely to divine it.
Although most agree that over recent decades R-star has fallen, its recent moves are more mysterious. An estimate published by the Richmond Fed suggests that it fell from around 2.2 per cent in April 2008 to 0.8 per cent two years later, but by April 2023 had recovered. By contrast, an estimate from the New York Fed finds that in April 2023 it was still around two percentage points lower than before the global financial crisis. In April, the IMF used a more complicated model to argue that it is probably still very low.