from the San Francisco Fed
– this post authored by Andrea Ajello, Isabel Cairo, Vasco Curdia, and Albert Queralto
The natural rate of interest, or r-star, is used to evaluate whether monetary policy is restrictive or supportive of economic activity. However, this benchmark rate can only be estimated, and policymakers’ misperceptions of the level of the natural rate can carry substantial economic costs in terms of unemployment and inflation. A scenario using mistaken perceptions shows that the costs of overestimating the natural rate are greater than the cost of underestimating it if policy space is limited by the effective lower bound on the nominal federal funds rate.
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