October 10, 2018

“R-star”: less cherished, but still useful

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In Short

R-star can be defined as the inflation-adjusted short term interest rate which prevails when the economy grows in line with its potential.
“R-star”: less cherished, but still useful
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Highlights:

  • Whether and when the Fed will have tightened too much is an issue that is gathering attention: One way to look at it is to compare the level of fed funds rates against the equilibrium short term interest rate (R-star), i.e. the rate consistent with balanced growth. In the past, policy rates rising above R-star preceded a recession by few quarters.
  • R-star is not observable and must be estimated with models. The wide range of estimates raises questions on its value as a gauge of the monetary policy stance and the Fed is downplaying its role. However, we show that it can still provide useful insights, especially on yields and bond-equity correlations.
  • The mild increase in potential growth and the wider fiscal deficit should raise R-star from its historically lows to levels consistent with a nominal rate of around 3%. However, adverse demographic trends will cap its upside potential.
  • Its very gradual and limited increase will widen the gap with respect to the Fed funds rate, resulting in a mildly tight monetary policy.

Read the full publication below.

“R-STAR”: LESS CHERISHED, BUT STILL USEFUL

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