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.