Despite the inflation spike resulting from the pandemic, there is “no evidence that the era of very low natural rates of interest has ended,” according to Federal Reserve Bank of New York President John Williams.
The natural rate of interest, also known as r-star, is a short-term interest rate adjusted for inflation. It’s the rate that’s expected to be in effect when the economy is strong and inflation is steady.
Before the pandemic, the measure was very low, about 0.5%, in economies all around the world.
However, the New York Federal Reserve Bank stopped giving estimates for r-star in late 2020. That’s because the economic impact of the pandemic was too unpredictable for the models.
Williams is also the vice chair of the Federal Open Market Committee or FOMC (the group that sets the federal funds rate). He said that the pandemic caused economic effects that went “far beyond” what the models were designed to handle.
The bank will relaunch its r-star estimate and will update it on a quarterly basis, said Williams in a prepared speech. He added that the resulting estimate of r-star in Q1 2023 is about 0.5%, and “subsequently falls to slightly below zero.”
The FOMC raised its benchmark interest rate to a range of 5.0%-5.25% since March 2022, up from almost zero.
They are currently discussing whether they should stop increasing the rate at their meeting on June 13-14, after 10 consecutive increases, to see how the aggressive tightening cycle has affected the real economy.
Williams did not discuss his short-term outlook for monetary policy or the economy.
But, on Tuesday he stated that inflation is moving in the right direction, although it still remains “unacceptably” high.
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