The neutral rate is the theoretical central bank interest rate target that would neither restrict nor fuel activity in an economy at full employment. Assessments of the neutral rate, also known as R-star, are essential to policy-setting.
Vanguard’s neutral-rate estimate is about half a percentage point higher than the estimate produced by the Laubach-Williams model, the Fed’s most frequently cited neutral rate source, named for its economist authors. We ran our higher neutral-rate assessment through the Fed’s macroeconomic model under a range of monetary policy rules. The results suggested that the median effective rate target would peak at 6% in 2023. The Fed’s current rate target is 5%–5.25%.
In the longer term, the median central bank target rate would need to settle at 3.5%, or a full percentage point higher than the median long-run outlook in the Fed’s most recent Summary of Economic Projections. These “higher for longer” findings support the idea put forth by Joe Davis, Vanguard’s global chief economist, in his January Wall Street Journal commentary (subscription required) suggesting that long-term investors stand to benefit from a new era of “sound money.”
The views below are those of the global economics and markets team of Vanguard Investment Strategy Group as of July 19, 2023.