Christopher J Waller: Some thoughts on r* - why did it fall and will it rise?

Speech by Mr Christopher J Waller, Member of the Board of Governors of the Federal Reserve System, at the Reykjavik Economic Conference, Reykjavik, Iceland, 24 May 2024.

The views expressed in this speech are those of the speaker and not the view of the BIS.

Central bank speech  | 
29 May 2024

Thank you for the invitation to be here and speak to you today.

I want to step away from shorter-term questions about the economic outlook and monetary policy to delve into a subject of longer-term significance-r*. While there are many concepts of r*, I interpret it to be the real policy interest rate that is neither stimulating nor restricting economic activity with inflation anchored at the central bank's inflation target. In the short term, policymakers must judge whether a given policy setting is restrictive or otherwise, and while this judgment is made with some idea of r*, a number of factors can influence the economy in the near term so that the current setting of policy usually differs from the value of r*. At the same time, policymakers continually update their view of the appropriate value of r*. Recently, for example, discussions have focused on whether or not r* has risen, which has important implications for the conduct of monetary policy.

For the purposes of this discussion, I am going to be talking about the long-run, real value of r*, when inflation and employment have reached the Federal Open Market Committee's (FOMC) goals. Because of that, an estimate of r* points toward where monetary policy is headed over the longer run. This is important for policymakers deciding the best way to get there and also for investors and other members of the public who make decisions in the near term based on their expectations of future economic conditions.

Much has been written on this topic, and different methods have been developed to estimate r*. My goal today is not to debate which statistical estimate of r* is best but rather describe what I believe are the economic factors behind the secular behavior of r*. In particular, I want to address two questions. First, what drove the decline in r* over the past 40 years? Second, what are the factors that may cause it to rise? I am certain some of you will disagree with my answers to these two questions, but that is the nature of good intellectual debate and how we advance our understanding of the world around us.