In December 2008, the Federal Reserve took the specific policy interest rate that it targets–the so-called “federal funds interest rate”–down to the range of 0% to .25%. The Fed then held the federal funds interest rate at this near-zero level for seven years, until December 2015. Since then, the Fed has raised the federal funds interest rate eight times in small steps, with the most recent step at its September 27 meeting, so that it now is in the range of 2% to 2.25%. How much higher is the Fed going to go?
Short answer: Four more interest rate increases by the end of 2019, taking the federal funds interest rate up to the level of 3% to 3.25%.
Longer answer: Robert S. Kaplan of the Dallas Federal Reserve explains in “The Neutral Rate of Interest” (October 24, 2018).
As Kaplan discussed, the Federal Reserve cut interest rates during the Great Recession and afterward, to stimulate the economy. But with the unemployment rate at 4% or less for the last six months, the Fed has been moving toward a “neutral” interest rate. Kaplan writes:
“The neutral rate is the theoretical federal funds rate at which the stance of Federal Reserve monetary policy is neither accommodative nor restrictive. It is the short-term real interest rate consistent with the economy maintaining full employment with associated price stability. You won’t find the neutral rate quoted on your computer screen or in the financial section of the newspaper. The neutral rate is an “inferred” rate—that is, it is estimated based on various analyses and observations”.
So what are the Federal Reserve policymakers current inferring? At each meeting, the participants provide their own estimates of the neutral rate. Kaplan writes:
“Each of us around the FOMC table submits quarterly, as part of the Summary of Economic Projections (sometimes referred to as the SEP or the “dot plot”), our best judgments regarding the appropriate path for the federal funds rate and the “longer-run” federal funds rate. My longer-run rate submission is my best estimate of the longer-run neutral rate for the U.S. economy. In the September SEP, the range of submissions by FOMC participants for the longer-run rate was 2.5 to 3.5 percent, and the median estimate was 3.0 percent. My own estimate of the longer-run neutral rate is modestly below the median of the estimates made by my colleagues. My suggested rate path for 2019 is also modestly below the 3 to 3.25 percent median of the ranges suggested by my fellow FOMC participants”.
