Goldman has a note today that will scare the willies out of Australians:
Central banks and especially financial markets believe that the neutral real short-term interest rate (r*) is extremely low. The major G10 central banks estimate r* at ¼-½%, while markets appear to be pricing about 0% in the US and -1½% in Europe. Are such low estimates plausible?
Ideally, we would use a structural model to answer this question. For example, the Holston-Laubach-Williams(HLW) model estimates an IS curve—the impact of the actual real short-term interest rate (r) on GDP—to back out r* as the value of r that puts the output gap at zero and inflation at 2%. But the IS curve fits the data poorly, i.e. r does not have a strong impact on GDP. Meanwhile, financial conditions, which do have a strong impact on GDP, are only loosely related to r.
The full text of this article is available to MacroBusiness subscribers
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.
