R-Star is Higher. Here's Why

We extend and update the canonical methodology of Laubach and Williams (2003) to estimate the neutral rate of interest for the United States. Using quarterly data from 1940 through the present, we show that r-star has risen by approximately 100 bps since the Great Recession, to 1.5% today. We attribute this rise to changes in factors unrelated to long-run trend growth. In our econometric estimates, we find potentially significant effects from demographics (i.e., aging) and structural U.S. fiscal deficits, with deficits having contributed to the recent, notable rise in r-star. To assess the policy implications, we feed these updated Laubach-Williams r-star estimates into the Federal Reserve’s FRB/U.S. macroeconomic model. Based on a higher neutral rate, the median effective federal funds rate remains above 5% until late 2024 even with higher unemployment projections. Most notably, the long-run federal funds rate settles at 3.5%, a level higher than presently reflected in the Federal Reserve’s Summary of Economic Projections (SEP). The structural nature of r-star’s rise suggests that those SEP projections will rise in the future