By Michael S. Derby
NEW YORK (Reuters) – The underlying level of interest rates viewed as neutral in economic influence held steady at a low level over the first three months of this year, according to data released on Friday by the Federal Reserve Bank of New York.
The bank said that R-Star stood at 0.7% in the first quarter of this year, unchanged from the revised reading reported for the final three months of 2023. The bank defines R-Star as the level of interest rates in place when the economy is expanding and inflation is stable.
The current R-Star reading suggests that the low interest rate world that has prevailed for a number of years still holds. R-Star has waxed and waned in importance for central bank policymakers but its relative stability contrasts with an evolution among officials toward an expectation that the era of super cheap borrowing costs that prevailed in the years leading up to the coronavirus pandemic may be over.
On Wednesday, as part of its latest set of quarterly forecasts, Fed officials revised up for a second straight time their estimates of the longer-run federal funds rate target. It was at 2.5% in December, moved up to 2.6% in the March estimates and now stands at 2.8%. That implies officials’ view of R-Star is rising as the forecast effectively takes the Fed’s 2% inflation target and adds an R-Star estimate, which suggests officials see the variable standing at around 0.8%, slightly above the current New York Fed offering.
Fed Chair Jerome Powell, speaking to reporters after the Federal Open Market Committee meeting, cautioned against reading too much into the shift higher in the Fed’s long-term rate forecast, noting the neutral rate of interest “really is a theoretical concept, can’t be directly observed.” R-Star estimates don’t “get you where you need to be to think about what appropriate policy is in the near term,” he said.
But Powell did allow that the longer-run rate forecast does signal an evolution. “People have been gradually writing it up, because I just think people are coming to the view that rates are less likely to go down to their pre-pandemic levels, which were very low by recent history measures,” he said.
New York Fed President John Williams, a leading figure in the formulation of the R-Star concept, agrees that R-Star is not particularly useful in making near-term tactical decisions about rates. But late last month he told reporters “the factors that have held down interest rates over the last decade or so, I think are still in play.
“I just don’t have the confidence that is sometimes expressed that the neutral interest rate is permanently higher, because I haven’t seen that in the data yet,” Williams said.
POLICY POTENCY
The demotion of R-Star comes as Fed officials have been struggling to understand how monetary policy influences the economy.
Despite very aggressive rate rises, the economy has not slowed as much as many economists and policymakers had expected, and that vigor has called into question whether rates have gone high enough to bring inflation back under control. By itself, R-Star points to clear restraint on the part of Fed policy.
Fed officials do agree monetary policy is restrictive, based on public comments. Meanwhile, a recent report from the Cleveland Fed said a mix of monetary policy rules indicate that the current level of the federal funds rate, at between 5.25% and 5.5%, is slightly more restrictive than the about 5% level suggested by those rules.
(Reporting by Michael S. Derby; Editing by Andrea Ricci)