MNI: Fed's Williams Throws Cold Water on R-Star Optimism

By Jean Yung

     WASHINGTON (MNI) - Incoming Federal Reserve Bank of New York President John

Williams reaffirmed his long-held views on the historically low level of the

neutral rate of interest Tuesday, noting that optimism over its potential to

rise amid new economic tailwinds is "misplaced." 

     The economist and thought leader on the topic continues to estimate that

the real neutral rate sits at around 0.5%, meaning the longer run fed funds rate

is roughly 2.5%. That is among the most pessimistic views on the Federal Open

Market Committee. 

     It would also mean that the Fed's policy rate would hit neutral in the next

year, as Williams said he backs three to four quarter-point hikes this year and

expects rates to continue rising next year. The FOMC in March predicted the fed

funds rate would hit 2.1% by the end of the 2018 and 2.9% by end-2019. 

     Demographics, productivity growth and global demand for safe assets

underpin r-star, Williams said. Despite speculation that fiscal stimulus would

create incentives to invest in capital equipment and research and development,

the resulting effect on r-star is likely to be "relatively modest," he said.

That's because the Republican tax cuts are front-loaded and could serve to bump

only U.S. growth. 

     At the same time, he has yet to see data that indicates current strong

economic conditions have increased the appetite for riskier assets, he said. 

     "Even as we raise rates, I'm conscious that the fundamental drivers that

govern r-star are lower than we've seen in the past," he said. "With a new

normal for short-term rates of around 2.5 percent, interest rates are likely to

remain low relative to historical experience." 

--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com