When it comes to the official US short-term interest rate, the Federal Reserve now appears to be on autopilot, with three more quarter-percentage-point increases likely by mid-2019. But after that, things should get more complicated.
To nobody’s surprise, the Fed delivered its latest increase this week and telegraphed its plans to do likewise when its policy-making committee meets again in December. And it’s entirely likely that it will follow the same script in March and June of 2019.
In other words, US monetary policy is likely to be a snooze over the next few quarters. But be sure your alarm clock is set to ring come June.
Trying to Get to Neutral
Why? It all comes down to the letter R. In economics parlance, R* is the symbol for the “neutral” rate of interest—the one that in theory keeps the economy in equilibrium if growth and inflation are near target.
With the US economy growing comfortably and inflation near 2%, the Fed believes it’s appropriate to reach that neutral rate of interest. The committee’s current estimate of R* is just short of 3%, or roughly 75 basis points higher than the current policy rate.
With Fed Chair Jerome Powell emphasizing that the current “gradual” pace of rate increases is the right one, it makes sense to expect additional 25-basis-point rate hikes in the next three quarters, which would bring the policy rate to the Fed’s estimate of neutral.
Obviously, things could change. Growth could slow, for example, or inflation could accelerate, forcing the Fed to change course. But for now, policymakers appear likely to continue their march toward the neutral rate.