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Fed's Williams says world of low interest rates still prevails

Published 05/19/2023, 08:48 AM
Updated 05/19/2023, 10:49 AM
© Reuters. FILE PHOTO: New York Federal Reserve President John Williams speaks at an event in New York, U.S., November 6, 2019. REUTERS/Carlo Allegri/

By Michael S. Derby

NEW YORK (Reuters) -New York Federal Reserve President John Williams said on Friday the U.S. and other major economies are still in a fundamentally low-interest-rate world despite the impact of the COVID-19 pandemic and the inflation surge that arose from it.

"There is no evidence that the era of very low natural rates of interest has ended" and the impact of the pandemic on estimates of what is called R-Star so far appears "relatively modest," Williams said at a U.S. central bank conference in Washington.

Compared with pre-pandemic R-Star estimates that often hovered around the 0.5% range, Williams said "the resulting estimate of R-Star is about 1/2 percent in the first quarter of 2023, and subsequently falls to slightly below zero."

Williams' remarks took on the technical concept of the natural rate of interest, referred to as R-Star, which the New York Fed defines "as the real short-term interest rate expected to prevail when an economy is at full strength and inflation is stable." Before the pandemic struck, this measure had been historically low, allowing the central bank to keep its interest rate target at fairly low levels.

But the pandemic and its shocks to the global economy, including high levels of inflation, obscured efforts to estimate R-Star, and the New York Fed stopped publishing its closely watched estimate in late 2020. Williams said that given efforts to understand how the pandemic had impacted R-Star, his regional Fed bank will once again provide an estimate on a quarterly basis.

According to the New York Fed's new estimate on Friday, R-Star stood at 1.16% in the final three months of last year, down from 1.81% in the final quarter of 2021. In data going back to 1961, the highest R-Star level was 5.26%, which was hit in the fourth quarter of that year.

To translate R-Star into a real-world rate depends on taking the variable and adding it to the central bank's 2% inflation target. Given Williams' current estimate of R-Star hovering somewhere between 0% and 0.5%, that points to a current Fed monetary policy stance, with a federal funds rate target range set at between 5.00% and 5.25%, that's deeply in restrictive territory.

© Reuters. FILE PHOTO: New York Federal Reserve President John Williams speaks at an event in New York, U.S., November 6, 2019. REUTERS/Carlo Allegri/

Williams, who also serves as vice chair of the central bank's rate-setting Federal Open Market Committee, did not comment on the economic or monetary policy outlook in his remarks. But his comments suggest that once the Fed's battle to contain high inflation is over, it may again at some later time be able to return short-term rates to low levels.

That said, Williams resisted efforts to connect his R-Star update to the Fed outlook, saying "I'm not going to opine on what monetary policy should or should not do" based on the measure.

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