Economics and markets
August 15, 2023
“R-star,” the real (inflation-adjusted) interest rate target that theoretically separates stimulative and restrictive central bank policies in an economy at full employment, has risen in recent years. In a technical paper published on the Social Science Research Network (SSRN), four Vanguard researchers contend that r-star—also known as the neutral or natural rate of interest—is 1.5% in the United States. Policymakers underestimate the rate, they argue, believing it to be about 0.5%.
“A higher neutral rate of interest in the U.S. will require the Federal Reserve to tighten monetary policy more aggressively than presently anticipated, potentially dampening the economic outlook in the short run and requiring a swift adjustment from private sector participants,” write Vanguard Global Chief Economist Joseph H. Davis; Ryan Zalla and Joana Rocha, both investment analysts; and Senior Economist Josh Hirt.
Looking at data from 1940–2022, conventional models for estimating r-star, and a Federal Reserve model for forecasting and analysis of macroeconomic issues, our researchers conclude that an aging population and rising fiscal deficits have pushed up the neutral rate of interest by about 100 basis points (1 percentage point) since the 2008 global financial crisis.
Explore the paper, R-star is higher. Here’s why.