For those of us growing up during the 1970s, two of the most popular birthday party games were pin the tail on the donkey and Twister. Since, then childrens’ parties have become much more expensive and high-tech; yet, when it comes to setting interest rates, it can be argued that central bankers of the world are still stuck playing these games of yore (and some are now arguing we may have returned to that ‘70s era as well!). For example, monetary policymakers at the Fed in the last few weeks have been twisting themselves around in complicated policy and rhetorical knots about the taper, as dictated by the latest color (or in this case economic data point) to appear when the wheel is spun. They are also still feeling around in the dark, blindfolded (and having been spun around), trying to find the donkey (i.e., the target equilibrium rate of interest) and discern where to pin its tail (the current chosen policy rate).
As we head into next week’s FOMC meeting, in this Economics Weekly, we discuss this target real equilibrium rate of interest—R* (r-star)—with the view that there are a number of reasons to believe we are near an inflection point, one where this longer-term real neutral rate could be starting to increase.
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Richard de Chazal, CFA is a London-based macroeconomist covering the U.S. economy and financial markets.