Opinion: The Neutral Rate Debate Is Missing the Point

The debate over the neutral rate of interest — that elusive r-star which neither stimulates nor restrains the economy — has consumed an inordinate share of monetary policy discussion this year. It is largely a waste of time.

R-star is not observable. It is a theoretical construct estimated from models that disagree with each other by wide margins. Real-time estimates have historically been revised substantially, often in the direction that would have made the current policy stance look more appropriate.

The more useful question is empirical: what is policy actually doing? Credit growth, housing activity, business investment, and hiring all provide evidence about the current stance. If the economy is growing at trend, unemployment is stable, and inflation is drifting toward target, policy is close enough to neutral for practical purposes.

This is not to say that neutral is meaningless. Long-run estimates matter for fiscal sustainability analysis, for exchange rate modeling, and for understanding secular trends in savings and investment. But for the FOMC's next meeting, the practical question is what the data show, not what a model implies about an unobservable parameter.

There is a deeper issue here about how central banks communicate. Anchoring policy discussion to a number that can be revised by a percentage point with a change in model specification invites unnecessary confusion. It also allows observers to argue about policy without engaging with outcomes.

The Fed under Chair Powell has, to its credit, shifted communication toward outcome-based framing. The September Summary of Economic Projections focused more on the projected path of unemployment and inflation than on where the funds rate needed to settle. More of that, and less r-star speculation, would serve both markets and the public.