Federal Reserve interest rates of 2% to 2.25% aren’t neutral if the inflation rate is 2.61%.
Federal Reserve Chairman Jerome Powell speaks in Washington, June 13. Photo: michael reynolds/EPA/Shutterstock
In “Pause Interest-Rate Hikes to Help the Labor Force Grow” (op-ed, Oct. 26), Federal Reserve Bank of Minneapolis President Neel Kashkari is mistaken in two important ways. Federal Reserve interest rates of 2% to 2.25% aren’t neutral if the inflation rate is 2.61%, as it is as of the third quarter of 2018. This gives a negative real interest rate of at least 0.36%. Only a positive rate of real interest in the 2% to 3% range is “neutral,” as during phases of the high-growth era of the 1980s and 1990s.
The Federal Reserve’s forcing of negative real interest rates for most of the 18 years since 2000, with the exception of about three years, has encouraged the substitution of capital for labor. This means the labor force gets paid less. This can help explain why the labor participation rate fell from 2000 to 2017, and now is finally starting to turn upward as interest rates rise.
Note that the Fed targets the personal consumption expenditures deflator index, and not the consumer price index, as a possible defense for President Kashkari. Everyone else across the globe uses the CPI as the key price-index measure of inflation.