Central bankers may be able to end their rate-hiking cycles before rates fall to target in part because monetary policy changes typically take months to work through an economy. In any case, Fed Chair Jerome Powell and ECB President Christine Lagarde have said that once policy rates reach their peak, they will have to stay high—in territory that restricts economic activity—for some time.
What’s restrictive monetary policy territory?
One definition deems a policy rate restrictive when real interest rates—nominal rates of interest minus rates of inflation—are positive. By this measure, real rates remain firmly negative in the euro area. In the U.S., they have turned marginally positive for some measures of inflation but not others.
A second definition deems a policy rate restrictive when it exceeds the “neutral rate of interest”—a theoretical rate that neither stimulates nor inhibits economic growth but supports the status quo. The Fed’s current rate target is roughly double its estimated range of the U.S. neutral rate. Similarly, in the euro area, the ECB deposit rate is roughly double that of some neutral rate estimates.
Taken at face value, the excess of policy rates over neutral rates suggest that rates are in restrictive territory. However, given that the neutral rate is not directly observable and can only be estimated with a large margin of error, it is hard to be confident we are there.2