Where’s Neutral? An Update

Participants’ estimates of the neutral fund’s rate have been influenced by estimates from models developed at the Fed, especially the work of Laubach-Williams (2003). That estimate had been near zero from 2008  until this May. Adding the August data produced a surprising and surprisingly large jump in their estimate,  bringing it in line with the central tendency of participants’ estimates. Still, as Williams has emphasized, one should look at other studies as well and be informed by a range of estimates. Here I show the revision to the  Laubach-Williams (2003) path of r-star and the average and range of the seven studies referred to in a recent  Monetary Policy Report. This average is nearly identical to the updated estimate from the Laubach-Williams  (2003) model. Notwithstanding the significant uncertainty of these estimates, participants appear to be guided in determining their rate paths by their respective estimates of the neutral rate. Perhaps FOMC participants will find comfort that the estimate from the Laubach-Williams (2003) model, as well as the average of the seven studies, is now in line with their median estimate. 

Laubach-Williams (2003) Estimates Through May 2018 

While Powell and Williams have recently downplayed the usefulness of estimates of the neutral rate,  participants’ estimates of the neutral rate have been influenced by those from the Laubach-Williams (2003)  model. The estimates cover the period from about 2008 through May have generally been negative or close to zero. The previous Chair, Yellen, cited the Laubach-Williams estimate of a near-zero real neutral funds rate as supporting a policy of remaining at a near-zero funds rate longer, even as the expansion was well underway,  and for longer than the Taylor rule and Taylor-like policy rules (including her own) prescribed. Other participants also cited the Laubach-Williams estimate to support their own views. In 2015, with the expansion well underway, she presented a revision to her rule that replaced participants’ median estimate of the neutral rate with a zero real neutral rate, and showed that that policy rule prescribed a positive, but still near-zero funds rate. 

The Revision in August 2018  

Remarkably, the additional data that became available after the May estimate, as well as revisions to the historical data used to estimate the path of r-star, could result in such a large, dramatic, revision to the estimate of r-star. By August, the revised estimates for the Great Recession and recovery were about 75 to  100 basis points higher than the May estimates. In Figure 1, I show the estimates from the Laubach-Williams  (2003) model in August and the previous estimates, from May. The latest estimate from their model is in line with the central tendency of participants’ estimates, 2.75% to 3% in nominal terms, and close to the median of 3%.

Averages and Ranges of Various Estimates  

There is a multitude of estimates of the neutral fund’s rate from a variety of models, many from the staff at the  Fed. In Table 1, I show estimates and the averages across the estimates from the seven models cited in the  July 2018 Monetary Policy Report.1 Before August, that average was 0.8%, or 2.8% in nominal terms (which is how participants report their estimates of the neutral rate). Recalculating the average with the upwardly  

1 Marco Del Negro, Domenico Giannone, Marc P. Giannoni, and Andrea Tambalotti (2017), “Safety, Liquidity, and the Natural Rate of  Interest,” Brookings Papers on Economic Activity, Spring, pp. 235-94, https://www.brookings.edu/wp content/uploads/2017/08/delnegrotextsp17bpea.pdf; Kathryn Holston, Thomas Laubach, and John C. Williams (2017), “Measuring the  Natural Rate of Interest: International Trends and Determinants,” Journal of International Economics, pp. 1, vol. 108 (May), pp. S59- 75; Benjamin K. Johannsen and Elmar Mertens (2016), “The Expected Real Interest Rate in the Long Run: Time Series Evidence with the  Effective Lower Bound,” FEDS Notes (Washington: Board of Governors of the Federal Reserve System, February 9),  

https://www.federalreserve.gov/econresdata/notes/feds-notes/2016/the-expected-real-interest-rate-in-the-long-run-time-series evidence-with-the-effective-lower-bound-20160209.html; Michael T. Kiley (2015), “What Can the Data Tell Us about the Equilibrium  Real Interest Rate?” Finance and Economics Discussion Series 2015-77 (Washington: Board of Governors of the Federal Reserve System,  September), http://dx.doi.org/10.17016/FEDS.2015.077; Thomas Laubach and John C. Williams (2015), “Measuring the Natural Rate of Interest Redux,” Hutchins Center Working Paper 15 (Washington: Brookings Institution, November), https://www.brookings.edu/wp content/uploads/2016/07/WP15-Laubach-Williams-natural-interest-rate-redux.pdf; Kurt F. Lewis and Francisco Vazquez-Grande (2017),  “Measuring the Natural Rate of Interest: Alternative Specifications,” Finance and Economics Discussion Series 2017-059 (Washington:  Board of Governors of the Federal Reserve System, June), https://dx.doi.org/10.17016/FEDS.2017.059; Thomas A. Lubik and Christian  Matthes (2015), “Calculating the Natural Rate of Interest: A Comparison of Two Alternative Approaches,” Economic Brief 15-10  (Richmond, Va.: Federal Reserve Bank of Richmond, October), https://www.richmondfed.org/- /media/richmondfedorg/publications/research/economic_brief/2015/pdf/eb_15-10.pdf. 

revised estimate from the Laubach-Williams model raised the nominal average across the seven models just  a little, to 2.9%, which is essentially FOMC participants’ median estimate. 

Given the recent discussion about the uncertainty around estimates of the neutral rate, I look at the range of point estimates of the real neutral rate across the seven models. The range was from 0.1% to 1.8% before the upward revision and is now 0.5% to 1.8%. That understates the uncertainty attached to the average across the seven models because it ignores the uncertainty attached to each of the individual estimates,  reflected in their 95% confidence bands. The width of those bands from the seven models ranged from 1.4  percentage points to 11.0 percentage points. 

Bottom Line 

It is somewhat comforting to me, at least, that the estimate from the Laubach-Williams (2003) model,  generally seen as an estimate of the short-run neutral rate, has converged to participants’ estimates of the fund’s rate in the longer run. Notwithstanding the uncertainty about the neutral rate, emphasized by Powell and Williams, participants appear to take their individual estimates as guideposts for judging when the FOMC  will have removed the remaining accommodation and reached the neutral rate. Participants almost universally  (except the course of President Bullard) agree that this is the immediate task of monetary policymakers, consistent with our rate projections. 

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