The so-called neutral rate of interest — or “r star,” as economists call it — is the standard against which the Federal Reserve’s interest-rate policy is judged as either “tight” or “loose.”
But a longstanding complication regarding this critical measure has been cropping up again lately in commentary shared by economists and market strategists. Because the neutral rate is a theoretical concept, nobody can say for certain exactly where it lies.
Since the start of the pandemic, senior Fed officials have espoused a wider range of opinions about where they see the neutral rate. As the central bank looks poised to continue cutting interest rates, this lingering uncertainty is starting to make some on Wall Street nervous.
Chief among their concerns is the possibility that the neutral rate might be higher than the Fed expects. If this turns out to be true, the central bank could inadvertently lower interest rates too aggressively, potentially contributing to another wave of inflation.