MNI: Central Banks Should Beware Of Chasing Higher R-Star- BIS

Central banks should be cautious about recent evidence that natural interest rates have climbed following the pandemic and instead look to more concrete observed inflation evidence, a Bank for International Settlements paper published Monday says.

There is some evidence in updated statistical modelling that the natural rate known as r* has increased after a decades-long decline, but there is a wide dispersion in the different estimates, according to the paper. Current estimates in different models vary by 2 percentage points, and in any case the measures of r* had fallen by several percentage points in past decades.

"Uncertainty surrounding r* suggests that it is a blurry guidepost for assessing the monetary policy stance and hence the tightness of monetary policy, in particular at the current juncture," according to the paper by authors including BIS analyst and former New York Fed official Gianluca Benigno. (See: MNI INTERVIEW: Fed To Ease Modestly In '24 - Ex NYFed's Benigno)

Central bankers including at the Fed and ECB are debating how soon inflation will moderate to a point where they can lower borrowing costs. One aspect of the discussions is whether monetary policy is looser than assumed because natural interest rates have nudged higher. (See: MNI INTERVIEW2: Ex-BOC Chief Says Neutral Rate Is Rising)

The BIS paper said the reversal away from an era where central banks were concerned with falling neutral rates and getting stuck at the "zero lower bound" shows why why relying on r* can be a problem. An update from the New York Fed Friday showed the Holston-Laubach-Williams model estimate of US r* edged down a tenth in the fourth quarter last year to 0.7%, the lowest since 2014.

“Very much like beauty, r-star is in the eyes of the beholder,” Claudio Borio, Head of the Monetary & Economic Department, told a press briefing. He also said “policymakers remain committed to completing the last mile of the inflation journey” and upside risks remain.

Another article in the BIS Quarterly Review said that signs of stickier prices for services mean "this possible slowdown of disinflation could prompt monetary policy to remain tighter for longer."