After cutting interest rates by more than a percentage point, Federal Reserve officials are now wondering where to stop \u2013 and finding there\u2019s more disagreement than ever.<\/p>\n
In the past year or so, prescriptions for where rates should end up have diverged by the most since at least 2012, when US central bankers started publishing their estimates. That\u2019s feeding into an unusually public split over whether to deliver another cut next week, and what comes after that.<\/p>\n
![\"\"](\"https:\/\/www.moneyweb.co.za\/wp-content\/uploads\/2025\/12\/445264684-555x306.jpg\")
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Fed Chair Jerome Powell has acknowledged \u201cstrongly differing views\u201d across the rate-setting committee about which of their two goals \u2013 stable prices and maximum employment \u2013 to prioritise. It boils down to a question of whether the economy needs a touch more gas to shore up job markets, or whether policymakers should take their foot off the pedal because inflation is above-target and tariffs could push it higher still.<\/p>\n
Read: 5 big market takeouts for 2025<\/p>\n
But that raises another question \u2013 one that\u2019s more abstract but increasingly important to the whole debate: what rate of interest would neither stimulate the economy nor squeeze it? This is the presumed endpoint of the cutting cycle. It\u2019s known as the \u201cneutral\u201d rate. And right now the collective Fed is struggling to figure out what it is.<\/p>\n
\u2018All over the place\u2019<\/span><\/h3>\nIn September, the last time they published projections, 19 officials came up with 11 different estimates, ranging from 2.6% to 3.9% \u2013 the latter number being roughly where rates are now.<\/p>\n
\u201cWe have people all over the place,\u201d says Stephen Stanley, chief US economist for Santander. \u201cThere\u2019s always a degree of disagreement on that, but the current range is wider.\u201d<\/p>\n
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Stanley also thinks the estimates are becoming more important, as the Fed\u2019s benchmark arrives at the upper edge of that range. \u201cIt starts to become potentially a binding constraint for some of the more hawkish Fed members,\u201d he says. \u201cIt definitely means that each successive cut becomes harder and harder.\u201d<\/p>\n
All of this is borne out in some recent Fedspeak. Philadelphia Fed President Anna Paulson explained on Nov. 20 why the twin risks of higher inflation and unemployment, combined with rates that may already be near neutral, have left her heading into the December meeting with caution.<\/p>\n
\u201cMonetary policy has to walk a fine line,\u201d she said. \u201cEach rate cut brings us closer to the level where policy flips from restraining activity a bit to the place where it starts to provide a boost.\u201d<\/p>\n
![\"\"](\"https:\/\/www.moneyweb.co.za\/wp-content\/uploads\/2025\/12\/445263806-555x319.jpg\")
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The neutral rate of interest is also known as r-star, based on the mathematical notation used to represent it in models, or the natural rate. It can\u2019t be directly observed, only inferred, and has generated intense debate for more than a century. Some economists, including John Maynard Keynes, have questioned whether it\u2019s really a useful tool at all \u2014 but few modern central bankers would agree.<\/p>\n
The idea is at the \u201cheart of monetary theory and practice,\u201d according to New York Fed chief John Williams, a specialist on the topic. He\u2019s argued that failure on the part of policymakers to diagnose shifts in the natural or neutral rates of interest and unemployment can have profound consequences, citing the spike in inflation expectations in the 1960s and \u201870s.<\/p>\n
The neutral rates are widely seen as driven by long-term shifts in things like demographics, technology, productivity and debt burdens, which affect patterns of savings and investment.<\/p>\n
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Which direction?<\/span><\/h3>\nAt the Fed, alongside the lack of consensus on where they are right now, there\u2019s also disagreement about which way they\u2019re headed.<\/p>\n
Minneapolis Fed President Neel Kashkari predicts that widespread adoption of artificial intelligence will lead to faster productivity growth, pushing the neutral interest rate up as new investment opportunities boost demand for capital.<\/p>\n
Read More: Fed Fixates on AI, But It\u2019s Not Ready to Make Big Greenspan Bet<\/p>\n
Fed Governor Stephen Miran, President Donald Trump\u2019s latest appointment to the central bank, says present-day policies should also play a part in the debate. In his first policy speech after joining the Fed, Miran made the case that Trump\u2019s tariffs, immigration curbs and tax cuts have combined to drive the neutral rate lower, even if only temporarily \u2014 so the Fed should ease policy sharply to avoid hurting the economy.<\/p>\n
Williams last month expressed doubts about allowing short-term changes into the calculation. He argues that global trends such as aging populations are holding estimates of the rate at historically low levels.<\/p>\n
![\"\"](\"https:\/\/www.moneyweb.co.za\/wp-content\/uploads\/2025\/12\/445264662-555x370.jpg\")
<\/p>\nNew York Fed chief John Williams<\/p>\n<\/div>\n
For a decade or so before the pandemic, when inflation was subdued and interest rates near zero, policymakers seemed to more or less agree where neutral was. But the surge in prices since then \u2013 as well as the uncertainty over trade and immigration, and what AI will do to the economy \u2014 have left some analysts wondering if diverging estimates are the new normal.<\/p>\n
What\u2019s more, the Fed is set for a change of leadership in 2026, with Trump vowing to pick a new chair who\u2019s committed to lower interest rates, and the president may have other opportunities to staff the central bank with his allies. The new policymakers are expected to argue for cheaper money, like Miran has, and may also estimate that neutral is lower right now.<\/p>\n
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CONTINUE READING BELOW<\/p>\n<\/p><\/div>\n<\/div>\n
\u2018Only a tool\u2019<\/span><\/h3>\nSince the neutral rate of interest is for economists what \u201cdark matter\u201d is to astronomers \u2014 something that can\u2019t be seen directly \u2014 there are policymakers who prefer to judge it, in Powell\u2019s words, \u201cby its works.\u201d<\/p>\n
St. Louis Fed President Alberto Musalem says low default rates show financial conditions remain supportive for the economy. His Cleveland Fed counterpart, Beth Hammack, says narrow credit spreads imply monetary policy is \u201conly barely restrictive, if at all.\u201d<\/p>\n
Drawing clues from financial markets, though, isn\u2019t a straightforward task. Some Fed officials see the yield on 10-year Treasury bonds, which has been hovering around 4%, as evidence that financial conditions aren\u2019t holding the economy back. Others say that those measures reflect expectations about the economy\u2019s path, as well as strong global demand for safe assets, meaning they\u2019re of little use when trying to estimate neutral rates.<\/p>\n
With so much uncertainty around the outlook, divisions over the neutral rate aren\u2019t likely to disappear when Fed officials reveal their latest estimates next week.<\/p>\n
Meanwhile, it\u2019ll be more concrete things \u2013 \u201cthe labor data and the price data\u201d \u2014 that drive actual policy calls, according to Patrick Harker, who headed the Philadelphia Fed until he retired this year.<\/p>\n
The neutral rate is \u201ca useful conceptual tool, but it\u2019s only a tool. It doesn\u2019t drive policy decisions,\u201d Harker says. \u201cI don\u2019t ever remember a case where everybody sat around and the entire conversation was, what is r-star?\u201d<\/p>\n
\u00a9 2025 Bloomberg<\/p>\n
Follow Moneyweb\u2019s in-depth finance and business news on WhatsApp here.<\/em><\/p>\n<\/p><\/div>\n
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CONTINUE READING BELOW<\/p>\n<\/div>\n<\/div>\n
Stanley also thinks the estimates are becoming more important, as the Fed\u2019s benchmark arrives at the upper edge of that range. \u201cIt starts to become potentially a binding constraint for some of the more hawkish Fed members,\u201d he says. \u201cIt definitely means that each successive cut becomes harder and harder.\u201d<\/p>\n
All of this is borne out in some recent Fedspeak. Philadelphia Fed President Anna Paulson explained on Nov. 20 why the twin risks of higher inflation and unemployment, combined with rates that may already be near neutral, have left her heading into the December meeting with caution.<\/p>\n
\u201cMonetary policy has to walk a fine line,\u201d she said. \u201cEach rate cut brings us closer to the level where policy flips from restraining activity a bit to the place where it starts to provide a boost.\u201d<\/p>\n
<\/p>\n
The neutral rate of interest is also known as r-star, based on the mathematical notation used to represent it in models, or the natural rate. It can\u2019t be directly observed, only inferred, and has generated intense debate for more than a century. Some economists, including John Maynard Keynes, have questioned whether it\u2019s really a useful tool at all \u2014 but few modern central bankers would agree.<\/p>\n
The idea is at the \u201cheart of monetary theory and practice,\u201d according to New York Fed chief John Williams, a specialist on the topic. He\u2019s argued that failure on the part of policymakers to diagnose shifts in the natural or neutral rates of interest and unemployment can have profound consequences, citing the spike in inflation expectations in the 1960s and \u201870s.<\/p>\n
The neutral rates are widely seen as driven by long-term shifts in things like demographics, technology, productivity and debt burdens, which affect patterns of savings and investment.<\/p>\n
ADVERTISEMENT:<\/p>\n
CONTINUE READING BELOW<\/p>\n<\/div>\n<\/div>\n
Which direction?<\/span><\/h3>\nAt the Fed, alongside the lack of consensus on where they are right now, there\u2019s also disagreement about which way they\u2019re headed.<\/p>\n
Minneapolis Fed President Neel Kashkari predicts that widespread adoption of artificial intelligence will lead to faster productivity growth, pushing the neutral interest rate up as new investment opportunities boost demand for capital.<\/p>\n
Read More: Fed Fixates on AI, But It\u2019s Not Ready to Make Big Greenspan Bet<\/p>\n
Fed Governor Stephen Miran, President Donald Trump\u2019s latest appointment to the central bank, says present-day policies should also play a part in the debate. In his first policy speech after joining the Fed, Miran made the case that Trump\u2019s tariffs, immigration curbs and tax cuts have combined to drive the neutral rate lower, even if only temporarily \u2014 so the Fed should ease policy sharply to avoid hurting the economy.<\/p>\n
Williams last month expressed doubts about allowing short-term changes into the calculation. He argues that global trends such as aging populations are holding estimates of the rate at historically low levels.<\/p>\n
<\/p>\nNew York Fed chief John Williams<\/p>\n<\/div>\n
For a decade or so before the pandemic, when inflation was subdued and interest rates near zero, policymakers seemed to more or less agree where neutral was. But the surge in prices since then \u2013 as well as the uncertainty over trade and immigration, and what AI will do to the economy \u2014 have left some analysts wondering if diverging estimates are the new normal.<\/p>\n
What\u2019s more, the Fed is set for a change of leadership in 2026, with Trump vowing to pick a new chair who\u2019s committed to lower interest rates, and the president may have other opportunities to staff the central bank with his allies. The new policymakers are expected to argue for cheaper money, like Miran has, and may also estimate that neutral is lower right now.<\/p>\n
\n\nADVERTISEMENT:<\/p>\n
CONTINUE READING BELOW<\/p>\n<\/p><\/div>\n<\/div>\n
\u2018Only a tool\u2019<\/span><\/h3>\nSince the neutral rate of interest is for economists what \u201cdark matter\u201d is to astronomers \u2014 something that can\u2019t be seen directly \u2014 there are policymakers who prefer to judge it, in Powell\u2019s words, \u201cby its works.\u201d<\/p>\n
St. Louis Fed President Alberto Musalem says low default rates show financial conditions remain supportive for the economy. His Cleveland Fed counterpart, Beth Hammack, says narrow credit spreads imply monetary policy is \u201conly barely restrictive, if at all.\u201d<\/p>\n
Drawing clues from financial markets, though, isn\u2019t a straightforward task. Some Fed officials see the yield on 10-year Treasury bonds, which has been hovering around 4%, as evidence that financial conditions aren\u2019t holding the economy back. Others say that those measures reflect expectations about the economy\u2019s path, as well as strong global demand for safe assets, meaning they\u2019re of little use when trying to estimate neutral rates.<\/p>\n
With so much uncertainty around the outlook, divisions over the neutral rate aren\u2019t likely to disappear when Fed officials reveal their latest estimates next week.<\/p>\n
Meanwhile, it\u2019ll be more concrete things \u2013 \u201cthe labor data and the price data\u201d \u2014 that drive actual policy calls, according to Patrick Harker, who headed the Philadelphia Fed until he retired this year.<\/p>\n
The neutral rate is \u201ca useful conceptual tool, but it\u2019s only a tool. It doesn\u2019t drive policy decisions,\u201d Harker says. \u201cI don\u2019t ever remember a case where everybody sat around and the entire conversation was, what is r-star?\u201d<\/p>\n
\u00a9 2025 Bloomberg<\/p>\n
Follow Moneyweb\u2019s in-depth finance and business news on WhatsApp here.<\/em><\/p>\n<\/p><\/div>\n
<\/p>\nNew York Fed chief John Williams<\/p>\n<\/div>\n
For a decade or so before the pandemic, when inflation was subdued and interest rates near zero, policymakers seemed to more or less agree where neutral was. But the surge in prices since then \u2013 as well as the uncertainty over trade and immigration, and what AI will do to the economy \u2014 have left some analysts wondering if diverging estimates are the new normal.<\/p>\n
What\u2019s more, the Fed is set for a change of leadership in 2026, with Trump vowing to pick a new chair who\u2019s committed to lower interest rates, and the president may have other opportunities to staff the central bank with his allies. The new policymakers are expected to argue for cheaper money, like Miran has, and may also estimate that neutral is lower right now.<\/p>\n
ADVERTISEMENT:<\/p>\n
CONTINUE READING BELOW<\/p>\n<\/p><\/div>\n<\/div>\n