Academic journal article ABA Banking Journal

What Is the Neutral Rate?

Academic journal article ABA Banking Journal

What Is the Neutral Rate?

Article excerpt

THE OUTLOOK FOR MONETARY policy has crystallized around the notion that the Federal Reserve will move the funds rate higher at a measured pace until it is at the so-called "neutral" rate. The neutral rate is sometimes defined as the policy rate that is neither inflationary nor deflationary: that is, the rate at which price stability prevails. Since modern central banks generally target a low average inflation rate, this translates into the interest rate consistent with the inflation target. In most major economies the target is around 2%. So the neutral rate would be the real funds rate that keeps inflation around 2%.

There are currently two quite different views about the appropriate neutral rate for the U.S. economy. The mainstream view is enshrined in the Taylor Rule, named after John Taylor, the economist currently serving as Under Secretary for International Affairs at the U.S. Treasury. Basically, the rule says the real rate needs to be proportionately higher as the inflation rate exceeds the Fed's target and proportionately lower as GDP (or employment) falls below potential.

Most applications of the Taylor Rule assume that the real neutral rate is around 2% or 3%. This is the mainstream view among economists today. In this view, assuming that the Fed successfully targets 2% inflation, the nominal rate would have to rise into the 4% to 5% range to achieve a "neutral" real rate of 2% or 3%.

There is another, albeit minority, view about the neutral rate. Its most vocal advocate is the economist and money manager Paul McCulley at PIMCO. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.