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For Fed, the ‘Neutral Rate’ Is Crucial, and Unknown

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Sept. 13: BofA’s Cabana Sees Risks That Fed Overdoes It on Rates

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Central banks seek to manage economies by setting interest rates at levels that speed up or slow down things like car purchases and construction projects. But the enterprise revolves around a number that’s far more ephemeral — the rate that does nothing at all, also known as the neutral interest rate. Right now, it’s an important guidepost because most monetary policy makers are trying to set rates high enough to bring down inflation -- but not so high as to guarantee a recession. Another number getting more attention than usual is the US Federal Reserve’s terminal rate -- the rate that marks the peak of a tightening cycle

In theory, the neutral interest rate is the rate at which monetary policy is neither stimulating nor restricting economic growth. As Fed Vice Chair Lael Brainard put it in a 2018 speech, it’s the level “that keeps output growing around its potential rate in an environment of full employment and stable inflation.” (The benchmark the Fed uses to direct monetary policy is known as the federal funds rate.)