The Decline in the Natural Interest Rate

I’ve written before about the natural interest rate. This is the idea that there’s a magic real interest rate that hangs over the entire globe. When the Fed goes below it, it’s pumping up the economy. When it goes above, it’s pulling the economy back.

The problem is that we never know exactly where the natural rate is. There are, however, some clues. Although we can’t see it, we can see its effects.

Mind you, there are plenty of economists who think all this is for the birds. But John Williams, top dog at the San Francisco Fed, takes it very seriously. He believes that since the recession, the natural rate has plunged, and I’m inclined to agree.

Williams and Thomas Laubach have teamed up to — what else do economists do — make a model of natural rates. Here’s a link to their paper on the subject. Here’s a spreadsheet of their data.

Remember that the natural rate is a real interest rate, meaning adjusted for inflation. I took the data from Williams and Laubach and added the real Fed fund rate. I based mine on core inflation which I think shows the trends better, though I understand some may disagree.

Notice how sharply the red line has plunged since 2008. If that’s right, that means the Fed hasn’t been pushing the economy as hard as you might think. The chart also shows just how aggressive Alan Greenspan was in the period after 9/11. He took the blue line well below the red line. Finally, you can see that the Fed is close to being neutral (meaning, red and blue are the same).

Posted by on November 28th, 2017 at 1:10 pm

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