There is an economic debate over the affect of rising interest rates upon the R*, otherwise known as the natural rate of interest, the Wicksellian rate, the Equilibrium rate, or the neutral rate. The definition of the natural rate is as follows:
The concept was originated by the Swedish economist Knut Wicksell who published a paper in 1898 defining it as a real short-term rate that makes output equal to natural output with constant inflation. Specifically, Wicksell defined the NRI as “a certain rate of interest on loans which is neutral in respect to commodity prices and tends neither to raise nor to lower themâ€.
It is hard to argue that the Fed cares much about the natural rate, since commodities often rise forcefully, and the cost of living is pinching main street. However, it says it does care, that it cares about price stability as one mandate. So what it plans to do with regard to the rate is the bone of contention for economists.
In this article it is necessary to discuss Scott Sumner’s views along with Kevin Erdmann’s views, with a mention of Donald Trump’s effort to corral the Fed. These ideas are counter-intuitive to what the Fed is doing, and yet absolutely sound assessments in normal economic times.
Unfortunately, we are not living in normal economic times.
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Real Gross Domestic Product Is Tired, and Has Been in Slow Decline Since the Beginning of Alan Greenspan’s Reign. |
The Brookings Institute has introduced an article entitled Measuring the Natural Rate of Interest Redux. The most significant conclusion made there is:
Given the uncertainty surrounding any estimate of the natural rate, they argue it might be prudent for the Fed to move away from relying on such estimates as a gauge for setting monetary policy. Second, if rates stay low for a prolonged period of time, Fed interest rates may be close to zero more often, suggesting a frequent need for unconventional monetary policy and the need to consider raising the Fed’s inflation target above its current 2% level. [Emphasis Mine]
