The equilibrium real interest rate continues to lie at the heart of discussions about economic policy in the US and elsewhere. Ben Bernanke has written that the equilibrium rate, and not the FOMC, is the ultimate determinant of interest rates in the economy, and claims that it is discussed at every Fed meeting. The recent debate about secular stagnation between Mr Bernanke and Lawrence Summers centres on a difference about the future path for the equilibrium rate. And Cleveland Fed President Loretta Mester says that it is “the issue policy makers are grappling with” at the FOMC.
Most important of all, Janet Yellen has focused all her intellectual firepower on the subject in her most important speech on monetary policy since she became Fed Chair. In this recent blog, I outlined the meaning of the equilibrium rate, and showed that the FOMC’s implicit forecast for that rate accounts for much more than half of the tightening in US rates indicated in the committee’s dots chart over the next 3 years.
The markets, however, do not believe the dots, and forward rates show a much smaller increase in US rates than the Fed indicates. The future path for bond and equity prices will depend largely on who is right about the equilibrium real rate: the Fed or the markets?
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SOURCE: Gavyn Davies – Read entire story here.
