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The equilibrium real policy rate through the lens of standard growth models

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  • Daniel E. Sichel
  • J. Christina Wang

Abstract

The long-run equilibrium real policy rate is a key concept in monetary economics and an important input into monetary policy decision-making. It has gained particular prominence lately as the Federal Reserve continues to normalize monetary policy. In this study, we assess the evolution, current level, and prospective values of this equilibrium rate within the framework of standard growth models. Our analysis considers as a baseline the single-sector Solow model, but it places more emphasis on the multi-sector neoclassical growth model, which better fits the data over the past three decades. We find that the long-run equilibrium policy rate has fallen between 0.3 and more than 1.6 percentage points from the 1973?2007 historical average, depending on the model and parameter values, mainly because of slower growth in total factor productivity (TFP) and the labor force. To the extent that the recent sluggish TFP growth persists, our estimates suggest a range of 0 percent to 1 percent for the equilibrium real rate in the current policy setting. But these estimates are subject to a substantial degree of uncertainty, as has been found in other studies. Policymakers thus need to interpret cautiously the guidance from policy rules that depend on the long-run equilibrium rate. This uncertainty also highlights the importance of the Federal Reserve?s standard practice of constantly monitoring a wide range of indicators of inflation and real activity to gauge as accurately as possible the economy?s reaction to policy.

Suggested Citation

  • Daniel E. Sichel & J. Christina Wang, 2017. "The equilibrium real policy rate through the lens of standard growth models," Current Policy Perspectives 17-6, Federal Reserve Bank of Boston.
  • Handle: RePEc:fip:fedbcq:2017_006
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    References listed on IDEAS

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    More about this item

    Keywords

    monetary policy; productivity; natural rate of interest; growth models;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • O33 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Technological Change: Choices and Consequences; Diffusion Processes
    • O41 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - One, Two, and Multisector Growth Models

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