Yesterday, the online version of The Washington Post had this short article offering several helpful definitions of the so-called neutral federal funds rate. Here's the text, in its entirety:
• The level at which the Federal Reserve's federal funds rate, the overnight rate charged between banks, neither stimulates nor slows economic growth.
• A rate that varies depending on economic conditions.
• A number that several Fed officials have recently pegged at between 3 percent and 5 percent.
• The subject of intense speculation as traders, investors and analysts guess how far the Fed will go in raising the rate over the next year or so.
• "A moving target," according to Fed Bank of Cleveland President Sandra Pianalto.
• A number that Fed Chairman Alan Greenspan has declined to specify, saying, "When we arrive at neutral, we will know it."
Actually, Sandy (my boss) had a little more to say on the subject. Here's an excerpt from a speech that I linked to in a previous post:
What do I mean by “neutral”? Well, in simple terms this means a federal funds rate that is no longer either accommodative or restraining. There is not one specific value for the federal funds rate that always equals a neutral policy stance. It’s a little like aiming at a moving target, and one that can seem a bit blurry at times.
The neutral range for the federal funds rate during the next several quarters and beyond will depend on how economic conditions unfold, but our experience suggests that during extended periods of reasonably sound and sustained economic performance, the neutral federal funds rate will almost certainly be above today’s level of 1.5 percent.
In fact, historical experience suggests that when our economy is operating soundly and when resources are at high levels of capacity utilization, the neutral range is likely to be 3 to 5 percent. Where does this estimate come from? Without going into the exact formula, the most important components in the equation are the rates of productivity growth and expected inflation. As either one of these factors moves up or down, so too will the neutral federal funds rate.