Sunday, October 18, 2015

The natural rate of interest?

Economists think its a real but unobservable rate od something.  What? Here is the FRSB defining it:
Since then, various definitions of the natural rate of interest have appeared in the economics literature. In this Letter, the natural rate is defined to be the real fed funds rate consistent with real GDP equaling its potential level (potential GDP) in the absence of transitory shocks to demand. Potential GDP, in turn, is defined to be the level of output consistent with stable price inflation, absent transitory shocks to supply. Thus, the natural rate of interest is the real fed funds rate consistent with stable inflation absent shocks to demand and supply.

So are we at potential growth?  
Fred says potential rowth is 2%, a drop from the 3.5% of the 80s.
Current growth is about 1.5%,  but that is a recent drop from the China slowdown.  And inflation is zero.  So, absent the China shock we are at zero inflation and operating at potential.  The current treasury rates are just fine. We do not have negative natural rates. If the natural rate were negative then inventory surpluses would be falling, that is negative growth.

So what caused potential growth to drop? Debt in DC and fiscal multipliers less than  one.

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