Raising Rates Won't Work
Why It Matters
This reframes the limits of monetary policy: with r* uncertain and historically low, rate cuts may be ineffective, making inflation expectations—and not just the policy rate—the central lever for restoring Fed flexibility. Market participants and policymakers should therefore watch inflation expectations and r* estimates closely, since they determine the Fed’s practical ability to ease or tighten policy.
Summary
The speaker argues the Federal Reserve is operating near the high end of an unobservable neutral rate (r*), and because r* has been close to the zero lower bound, conventional rate cuts can no longer meaningfully stimulate the economy. Raising inflation expectations is the mechanism that can effectively lift r* away from the lower bound, which in turn justified the large rate increases after the COVID-era inflation shock and allowed the Fed to move policy well above zero. The talk stresses that r* is estimated with great uncertainty, so policymakers face a tricky trade-off: they must manage inflation expectations to regain policy space while risking further distortion of financial conditions.
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