Admin

Chasing r* | The Fed's Intangible Goal

By
Real Estate Agent with 1313 14th St NW DC 20005 Licensed in DC & VA

Next week, the Fed will hold its final FOMC meeting to decide on policy for America's benchmark interest rate. 

The CME FedWatch tool puts the likelihood of a rate cut at 96.7% and most contributors are betting on a quarter-point reduction. But experts agree that future Fed policy is uncertain, as the Open Market Committee chases r*.

What Is R Star?

It's the real short-term interest rate achieved when the economy is at full employment and stable inflation, the neutral rate when monetary policy isn't stimulated or restrained by monetary policy. This is the benchmark Central banks use to set interest rates.

The question is, why does the Fed always seem to be chasing r* and what is the rate of r star today?

It's a question even the Fed doesn't agree on. There's no simple answer because the r* bar is always changing.

The r* is a theoretical idea which can never be directly observed. By definition, 'not directly observable' is something that can't be seen, measured or perceived directly by senses or readily available methods, instead inferred or understood only through its effects on observable things.

So the Fed is trying to hit a nebulous, moving target.

Unlike other economic indicators, there's no one data point that directly measures r-star.

Determining r* involves complex equation that includes factors like potential economic growth and determining how fast it can expand without lifting inflation and making assumptions about future economic conditions (and you know the old saying about making assumptions!).

Economic Growth

Higher capital returns generated by faster GDP spur higher interest rates. Potential GDP is a function of two factors: productivity and labor.

Labor, Productivity & Unemployment
Labor influences overall economic output and inflation expectations. A tight labor market with low unemployment and high wages  can push r* upward due to potential inflationary pressures, while a slack labor market can lower r* due to reduced inflationary concerns.

  • Labor productivity also factors in. When productivity is high (more output with the same amount of labor), it can contribute to lower inflation.
  • Rapid wage increases in a tight labor market can signal potential future inflation, leading to a higher r* as central banks try to cool the economy.
  • A low unemployment rate often indicates a strong labor market, which can push r* higher due to potential inflationary pressures.

Contributing factors are constantly changing, which is why the Fed relies heavily on the Core PCE Index, also factoring in CPI and PPI in determining its rate decisions.  Adjustments are made at the eight annual FOMC meetings.

Isn't There An App For That?

Ha, no, but there are two models economists use to calculate r*:

  • Laubach-Williams (LW): A semi-structural model developed in 2001 by economists Thomas Laubach and John C. Williams of the Federal Reserve Bank of New York.
  • Holston-Laubach-Williams" (HLW): An extension of LW by Kathryn Holston, incorporating additional analysis and features allowing for the application to a wider range of advanced economies and accounting for more complex economic factors like time-varying volatility.

Take a peek into explainers on these two models and you will quickly be led down a deep, dark rabbit hole of macroeconomics. For those of us  simply wanting to know when rates are coming down and asking why those pulling the levers of our economy are still chasing r*, the answer is that the Fed's only option is educated guesswork. That might not be the most comforting conclusion, but it is the most accurate.

Find the latest Fed r-star rate and other scintillating insights on our National Real Estate Market page.

Happy December!

 

Posted by

Susan Isaacs, Realtor

The Isaacs Team LLC

Partnering With DOMO

Compass

1313 14th Street NW DC 20005

Find us at:

realestateinthedistrict.com

Equal Housing Opportunity

Copyright - All rights reserved The Isaacs Team LLC

Comments(0)