A shift is underway at the Federal Reserve in how to describe neutral -- the interest-rate level that neither stimulates nor restrains growth -- as it debates how much higher to hike.

For an abstract concept -- neutral can’t be directly measured -- the stakes are high: If the assessment is too low, Fed policy could be providing more stimulus to the economy than thought as it fights inflation. If it’s too high, policy is more restrictive than planned. Both can result in a damaging policy error.

The topic is moving up the policy agenda because in July, the Fed raised the top of its target range for the benchmark federal funds rate by 75 basis points to 2.5%, which Chair Jerome Powell noted met officials’ estimate of the long-run neutral rate.

That move completed the first stage of the tightening cycle begun in March, when policy makers said they wanted to get to neutral “expeditiously” to cool surging inflation.

With officials beginning stage two of the campaign -- as Powell laid out Aug. 26 in Jackson Hole, Wyoming -- the discussion has turned to how much higher they now have to go and how long to stay when they get there.

That’s also elevating the argument that neutral is currently higher than the Fed’s long-run median estimate -- which in June was 2.5% -- indicating rates need to be hiked further than otherwise. Powell has said that another unusually large increase could be on the table when officials next meet Sept. 20-21, depending on the data, and some policy makers want to see rates rise above 4%.

But estimates of neutral can vary widely. Just 39% of economists surveyed by Bloomberg in August agreed with the FOMC’s view of neutral at 2.5%, with estimates ranging from 2% to 3.75%.

And it’s a hard thing to talk about.

Powell was slammed for announcing after the July 27 rate increase that the move had lifted rates into the range of neutral. Critics argued the comment had fanned a rally in stocks as investors took it as a dovish hint that rates didn’t have much higher to go.

Former Treasury Secretary Lawrence Summers, a paid Bloomberg TV contributor, said the remark was “indefensible” because 2.5% was not anywhere near neutral given current high inflation. Mohamed El-Erian, chief economic adviser to Allianz SE and a Bloomberg Opinion contributor, said “the zip code for neutral is above where we are now,” and at least 50 basis points higher.

St. Louis Fed President James Bullard, among the most hawkish at the US central bank, says the 2.5% estimate might make sense if the economy were on balanced growth path with 2% inflation projected ahead -- conditions contrary to the post-Covid-19 reality.

“That is not where we are today,” Bullard said in a Aug. 26 Bloomberg TV interview at Jackson Hole. “We’ve got all this inflation and we’ve got a very strong labor market. So that’s why it makes sense to go well above that to a recommended policy rate that’s well above that.”

San Francisco Fed President Mary Daly said neutral is “around 3%” and she’d like to get to “restrictive” rate of more than that to push against demand. “We need to bridle back the economy a bit,” she said in a Aug. 18 interview with CNN International.

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