The Asymmetric Costs of Misperceiving R-star

Andrea Ajello, Isabel Cairó, Vasco Cúrdia, and Albert Queralto

2021-01

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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FedViews: January 14, 2021

Kevin J. Lansing, research advisor at the Federal Reserve Bank of San Francisco, stated his views on the current economy and the outlook as of January 14, 2021.

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