Abstract
In A National Balance Sheet Approach to the Natural Rate of Interest, from the summer 2023 issue of The Journal of Fixed Income, Robert Goldberg and Mariano Torras of Adelphi University estimate the “natural rate of interest” for the US economy based on macroeconomic fundamentals. They call their estimator of the natural rate of interest pa.2023.pa586_Ieqn1 (R-hat), to distinguish it from the Federal Reserve’s estimator r* (R-star). They find that pa.2023.pa586_Ieqn2 has been significantly higher than r* for at least two decades. The upshot is that the Fed’s monetary policy has been overly accommodating for that whole time. The authors assert that r* underestimates the true natural rate of interest because the Fed’s methodology fails to capture two key items: 1) lower risk premiums stemming from investors’ perception that the Fed will provide a backstop to the financial system and 2) changing capital structures that include higher leverage than in the past. The results suggest that investors could have benefited from higher allocations to risky assets (e.g., stocks vs. bonds) while policy actions were more accommodating than intended.