R-Star is Higher. Here's Why

16 Pages Posted: 23 Jun 2023 Last revised: 10 Aug 2023

See all articles by Joseph H. Davis

Joseph H. Davis

The Vanguard Group

Ryan Zalla

The Vanguard Group

Joana Rocha

Vanguard

Josh Hirt

Vanguard

Date Written: June 14, 2023

Abstract

We extend and update the canonical methodology of Laubach and Williams (2003) to estimate the neutral rate of interest for the United States. Using quarterly data from 1940 through the present, we show that r-star has risen by approximately 100 bps since the Great Recession, to 1.5% today. We attribute this rise to changes in factors unrelated to long-run trend growth. In our econometric estimates, we find potentially significant effects from demographics (i.e., aging) and structural U.S. fiscal deficits, with deficits having contributed to the recent, notable rise in r-star. To assess the policy implications, we feed these updated Laubach-Williams r-star estimates into the Federal Reserve’s FRB/U.S. macroeconomic model. Based on a higher neutral rate, the median effective federal funds rate remains above 5% until late 2024 even with higher unemployment projections. Most notably, the long-run federal funds rate settles at 3.5%, a level higher than presently reflected in the Federal Reserve’s Summary of Economic Projections (SEP). The structural nature of r-star’s rise suggests that those SEP projections will rise in the future.

Keywords: natural rate of interest, monetary policy rules, trend growth

JEL Classification: C32, E43, E52, O40

Suggested Citation

Davis, Joseph H. and Zalla, Ryan and Rocha, Joana and Hirt, Josh, R-Star is Higher. Here's Why (June 14, 2023). Available at SSRN: https://ssrn.com/abstract=4478413 or http://dx.doi.org/10.2139/ssrn.4478413

Joseph H. Davis

The Vanguard Group ( email )

100 Vanguard Blvd
Malvern, PA 19355
United States

Ryan Zalla (Contact Author)

The Vanguard Group ( email )

100 Vanguard Blvd
Malvern, PA 19355
United States

Joana Rocha

Vanguard ( email )

100 Vanguard Blvd
Malvern, PA 19355
United States

Josh Hirt

Vanguard ( email )

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