Estimating the \\"neutral\\" real interest rate in real time

Tao Wu ()

FRBSF Economic Letter, 2005, issue oct21

Abstract: On September 20, the Federal Open Market Committee, the nation's monetary policymaking body, raised its target level of the federal funds rate by 25 basis points, the eleventh straight increase over the last fifteen months. The statement released immediately after the meeting said, \\"With underlying inflation expected to be contained, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.\\" ; The statement clearly implies that the Committee believes that the real funds rate is below the so-called neutral real rate. What is the \\"neutral real rate\\"? According to Greenspan (1993), the real funds rate may be said to be neutral when it is at a level that, \\"if maintained, would keep the economy at its production potential over time.\\" Therefore, if the real funds rate is below the neutral real rate, policy is accommodative and the economy expands; if it is above the neutral real rate, policy is restrictive and the economy shrinks. ; The difficulty policymakers face is that it is not obvious exactly what the level of the neutral real rate is. It cannot be observed directly. There is no reliable way to estimate it. And it can change. ; This Economic Letter discusses the problems of estimation using both statistical methods and structural economic models. It focuses particularly on the vagaries of such estimations done in \\"real time,\\" that is, without the benefit of long and reliable series of data.

Keywords: Interest rates; Monetary policy (search for similar items in EconPapers)
Date: 2005
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