As prepared for delivery
Presentation accompanying the speech
For over 125 years, economists have grappled with a dilemma: How can a concept at the very heart of monetary theory be so vexing to quantify? I'm talking, of course, about r-star, the natural rate of interest. The quotations listed in Table 1 reflect the age-old challenges surrounding it. Recently, r-star has been in the spotlight once again.
Today, my remarks will focus on longer-run r-star, which is the real interest rate expected to prevail when shocks to the economy have receded and the economy is growing at its potential rate.
Before I go further, I'll provide the standard Fed disclaimer that the views I express today are mine alone and do not necessarily reflect those of the Federal Open Market Committee (FOMC) or others in the Federal Reserve System.
Three Approaches
Subsequent to Milton Friedman's claim to the contrary, there are now three common approaches to inferring r-star from data: using a statistical method to extract a longer-run trend, basing it on financial market or survey data, or looking at r-star's effects on economic data. Each provides useful information, but each also poses significant challenges. As discussed in one of my papers with Thomas Laubach, univariate statistical methods do not adequately control for economic factors that influence interest rates. And these estimates can be overly influenced by large macroeconomic disturbances, such as the inflation of the 1970s or the pandemic. Financial market and survey data are subject to measurement issues and, in any case, tell us what people are thinking about r-star, rather than act as an independent source of information on r-star. This is what I have referred to as a "hall of mirrors."
For these reasons, I will focus my remarks on estimates of r-star gleaned from macroeconomic models that do not rely on financial market or survey data-in particular, the Holston-Laubach-Williams (HLW) model, which infers the natural rate of interest through the behavior of interest rates, inflation, and GDP. Or, as the economist John H. Williams put it, "by its works."