In Search Of The Elusive Neutral Rate

Federal Reserve officials aren’t sure how high rates need to rise to end stimulus

- Peter Coy

The word “neutral” is usually as boring as beige. But not when it’s coupled with “interest rate.” Stocks leaped on Nov. 28 when Federal Reserve Chairman Jerome Powell opined that short-term interest rates were just below their “neutral” range. Investors concluded that the central bank was almost done raising interest rates, sending the Dow Jones industrial average up 618 points, or 2.5 percent.

Powell, 65, is a seasoned Washington lawyer, ex-Treasury official, and former private equity executive who served on the Fed’s Board of Governors for six years before President Trump elevated him to chairman in February. He knows all about message discipline. Yet in alluding to the neutral interest rate, he waded into one of the biggest controversies in economics. Even within the Fed’s Federal Open Market Committee (FOMC), which sets the target for the benchmark federal funds rate, there’s deep disagreement on the topic.

One handy definition of the neutral interest rate is the rate that you’d want when the economy is at Goldilocks perfection. In that situation, there’s no need to raise interest rates to dampen inflation pressures or lower them to encourage companies to hire. Keeping the rate at neutral is like driving with cruise control—you can keep your foot off the gas and off the brake.