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The author is Head of Macro Research at BNP Paribas Asset Management.
It’s almost time for many people to start making New Year’s resolutions. Here are some suggestions for those setting interest rates: Please publish your estimates of how much you expect interest rates to settle over the medium term.
Policymakers are often asked about the location of the so-called neutral interest rate, but they rarely give an accurate answer. At the moment, the default reaction is for interest rates to be above neutral, but by how much is very difficult to know. Many policy makers are reluctant to provide point estimates for model-based concepts that are highly uncertain and unobservable. Nevertheless, the argument for more discussion about the neutral interest rate is persuasive.
The neutral interest rate is the level of the policy interest rate required to keep demand increasing in line with supply over the medium term. It’s not a fixed number. The neutral level would be shifted to offset shocks that could have a permanent and significant impact on economic spending. Your estimate of neutrality is therefore a good summary statistic for medium-term forecasts of spending and the factors that shape it, such as changes in fiscal stance, economic uncertainty, and foreign export demand.
The location of the neutral interest rate is an important element of the policy debate. Policy makers should therefore have a constant desire for neutral estimates. It is necessary to know whether the current policy interest rate is “tight” (above neutral) or “loose” (lower). In other words, is policy restraining or stimulating spending? — If you want to accurately estimate the impact of policy interest rates on the economy, you also look at their amounts. The decision to publish neutral estimates will focus attention and resources within the central bank on refining the estimates to the benefit of policy debates.
Discussing the position of neutral countries should also help policymakers pursue economic stability. Expectations of future interest rate trends influence broader monetary and financial conditions, such as the level of fixed-rate mortgages and the value of currencies, which in turn shapes the path of spending in the economy. Providing neutral quantitative estimates can help anchor these expectations for policy rates in place, reducing volatility in broader monetary and financial conditions and ultimately stabilizing spending. There is sex.
Otherwise, policymakers may inadvertently legitimize the current market view of neutrality in the current regime. Central bank forecasts are usually based on the assumption that interest rates will be as expected by investors. If these forecasts show near-trend growth at the end of the forecast period (as is often the case), investors can reasonably assume that the central bank shares the market’s view of a neutral position. Masu. Policymakers may want to reflect on whether they want to send that signal.
Neutral interest rate estimates often turn out to be wrong. That’s no excuse for not publishing them. A central bank’s reputation is based on its ability to make important decisions correctly, not on the accuracy of the estimates it publishes. Transparency in input into decisions also helps preserve reputation in the event of mistakes. Some central banks have already crossed the Rubicon on this issue. If we can publish an estimate of the “output gap” between the level of demand and the unobservable level of supply, we can also publish an estimate of the neutral interest rate.
There are legitimate concerns about spurious precision in point estimates, but it’s also very easy to convey uncertainty about the estimates. Each policymaker can propose an estimate of the location of a neutral country and the uncertainty surrounding that number, which can be aggregated to create a coherent joint communication on the subject.
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Refusing to publish neutral estimates can begin to undermine policy communication. If policymakers remain silent about the latter position as interest rates continue to fall, it will become increasingly difficult to argue that policy rates are still above neutral. Policymakers may feel they have to stop talking about whether policies are restrictive, but that would be a step backwards.
In any case, there are compelling arguments to make it public for reasons of transparency alone. It is standard to disclose all important judgments that influence policy decisions, including clearly the position of neutral countries. An increasing number of central banks are publishing their views on the position of neutral countries. The sky is not falling.
The ultimate New Year’s resolution will be to announce a likely path for policy rates to return to neutrality. A good place to start is by estimating how interest rates will stabilize over the medium term.
