In a recent speech at the Economic Club of New York, Fed Governor Jay Powell stated that the endpoint of the Fed’s normalization process “will occur when our target reaches the long-run neutral rate of interest. Estimates of that rate are subject to significant uncertainty. The median estimate of its level by FOMC participants in March was 3 percent, more than a full percentage point below pre-crisis estimates.” The neutral rate of interest is commonly designated as R*. (Sometimes R* is stated in real terms, rather than nominal terms. With an inflation target of 2 percent, a real neutral rate would would be 1 percent according to the FOMC median of 3 percent nominal.)

Actually the estimated drop in R* is quite recent: the FOMC median nominal R* was 4 percent just 4 years ago, which illustrates the uncertainty. It’s a very important issue: If there has actually been a drop, then, as some argue, the Fed should be ready for another zero lower bound event with more quantitative easing or even a higher inflation target. If there has not been a drop, then the Fed’s normalization endpoint will likely be the type of policy used in the 1980s and 1990s.

To take a deep dive into the issue, the Hoover Institution and the Stanford Institute for Economic Policy Research held an R-STAR WARS debate between two of the world’s foremost experts on this question, with me as moderator. On one side was Volker Wieland of Goethe University of Frankfurt and the German Council of Economic Experts. On the other was John C. Williams of the Federal Reserve Bank of San Francisco and a member of the FOMC.  Williams argued that the neutral rate is now much lower than in the past. Volker Wieland argued that there has been no such decline. Each made a good case in my view, but you be the judge. Here is a video of the debate in three parts: Opening remarks, Questions from Taylor, and Questions from the audience.  At the least you will see why Powell says there is “significant uncertainty,” and perhaps that is the main takeaway for policymakers.