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R-star wars: the phantom menace

Abstract

The natural real rate of interest has been on a declining path for the past 30 years. I present a regime-switching analysis of the natural rate, which suggests that the current low levels are likely to persist in the near future. I identify a high global demand for safe assets as the most important factor in keeping the natural rate low. I conclude that the current low levels of the policy rate are generally appropriate, with some upside risk, and that forward guidance should be characterized by a flat policy rate path.

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Fig. 1

Sources Federal Reserve Board, Federal Reserve Bank of Dallas, Taylor (1993), Del Negro et al. (2017), Holston et al. (2017), and author’s calculations. Last observation: 2017-Q4. (Color figure online)

Fig. 2

Sources Gomme et al. (2015), Federal Reserve Board, Federal Reserve Bank of Dallas, and author’s calculations. Last observation: 2017-Q4. (Color figure online)

Fig. 3

Sources Kahn and Rich (2006, 2007) and Federal Reserve Bank of New York. Last observation: 2017-Q4. (Color figure online)

Fig. 4

Sources Bureau of Labor Statistics and author’s calculations. Last observation: January 2018. (Color figure online)

Fig. 5

Source Author’s calculations. Last observation: December 2017. (Color figure online)

Notes

  1. 1.

    For an introduction to regime switching, see Hamilton (1989) and Kim and Nelson (1999).

  2. 2.

    This method is using ex-post inflation. Forward-looking measures, based on Federal Reserve Bank of Cleveland data on inflation expectations, are similar but more volatile.

  3. 3.

    See Gomme et al. (2011, 2015), Monge-Naranjo et al. (2015), and Dupor (2015). For an alternative perspective on this issue, see Williams (2017).

  4. 4.

    For some analysis along this line, see Lagos (2010).

  5. 5.

    Available at https://www.newyorkfed.org/medialibrary/media/research/national_economy/richkahn_prodmod.pdf.

  6. 6.

    The inflation target is in terms of the annual change in the price index for personal consumption expenditures (PCE).

  7. 7.

    See Bullard (2016) for more details on the St. Louis Fed’s approach to characterizing the U.S. economic outlook.

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Correspondence to James B. Bullard.

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This article is an extended version of remarks delivered at the 34th Annual NABE Economic Policy Conference, Washington, DC, February 26, 2018. The author appreciates the assistance and comments provided by colleagues at the Federal Reserve Bank of St. Louis. Any opinions expressed here are the author’s own and do not necessarily reflect those of the Federal Open Market Committee.

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Bullard, J.B. R-star wars: the phantom menace. Bus Econ 53, 60–65 (2018). https://doi.org/10.1057/s11369-018-0077-1

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Keywords

  • Natural real interest rate
  • Markov switching
  • Monetary policy rules

JEL Classification

  • C24
  • E47
  • E58