Fed’s Williams says natural rate of interest still low despite pandemic

By Michael S. Derby

NEW YORK (Reuters) – Federal Reserve Bank of New York President John Williams said Friday the U.S. and other major economies are still in a fundamentally low-interest-rate world despite the impact of the coronavirus pandemic and the inflation surge arising from it.

Speaking to a conference at the Federal Reserve in Washington, Williams’ remarks took on the technical concept of the natural rate of interest, which is the interest rate that neither slows nor stimulates the economy. Before the pandemic struck, this measure, referred to as R-Star, had been historically low, allowing the central bank to keep its interest rate target at fairly low levels.

But the pandemic and its shocks to the global economy, as well as the resulting high level of inflation, obscured efforts to estimate R-Star and the New York Fed stopped publishing its closely watched estimate in late 2020. Williams, a leading intellectual architect of the R-Star concept, said his bank would be relaunching its public estimate Friday, updating it on a quarterly basis.

Williams’ contended that even with the pandemic and the aftermath of its most acute phase, the fundamental story of a low natural interest rate remains in place.

“According to the model estimates, the main longer-term consequence from the pandemic period is a reduction in potential output, but the imprint on R-star appears to be relatively modest,” Williams said, adding “importantly, there is no evidence that the era of very low natural rates of interest has ended.”

Compared with pre-pandemic R-Star estimates that hovered around the 0.5% range, Williams said “the resulting estimate of R-star is about 1/2 percent in the first quarter of 2023, and subsequently falls to slightly below zero.”

Williams, who also serves as vice-chairman of the rate-setting Federal Open Market Committee, did not comment on the economic or monetary policy outlook in his remarks. But his comments suggest that once the Fed’s battle to contain high inflation is over it may again at some later time be able to return short-term rates to low levels.

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