Monday, June 27, 2016

The Fed and Bernanke Are Wrong About the Natural Interest Rate

If the Fed would quit meddling with interest rates, the natural interest rate would be revealed.

A few days before the last FOMC meeting The Wall Street Journal reported on the Fed's hand wringing over its inability to identify the “natural rate of interest” and explain its recent movements.

According to Fed economists, the natural rate is “unobserved” and therefore “has to be inferred from observable data” using econometric models or other statistical techniques. But different models yield different estimates of the natural rate.

These estimates range from “persistently negative since 2008” to a “reasonable range” between 1% and 2%. Nor are these estimates very precise. One model estimates a natural rate of 0.5% from 2010–2015 with a 90% confidence interval of 4 percentage points, meaning that there is a 90 percent probability that the natural interest rate lies somewhere between -1.5% and 2.5%.

Another model yields an estimate of the natural rate for the year 2000 that includes both 0% and 6% within the 90% confidence interval! But the main problem befuddling monetary policymakers is that almost all estimates have indicated that the natural rate has fallen precipitously from 2 to 2.5% leading up to the financial crisis to near or even slightly below zero and has remained there since 2009. Further deepening the mystery is that the rate shows no signs of recovering..... Read more

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