US rates will rise less than in previous expansions – Fed’s Williams

Despite stronger growth in 2017 and the Fed’s tighter policy stance, the natural rate of interest in the US will be much lower than in the past, John Williams said on May 15.

The San Francisco Fed president spoke at the Economic Club of Minnesota about his outlook on the natural rate of interest or “r-star”. He defined this as “the real interest rate expected to prevail when the economy is at full strength”. Williams considers it is around 0.5%.

 “Assuming inflation is running at our goal of 2%, that means the typical, or normal short-term interest rate is 2.5%,” Williams said. This is “an incredibly low level – in fact, a full two percentage points below what a normal interest rate looked like just 20 years ago”, he said.

Williams said that “recently some economists and central bankers have pointed to signs” that r-star is set to rise. “I don’t yet see convincing evidence of such a shift,” he said “The longer-run drivers still point to a new normal of a low r-star and relatively low interest rates.”

In William’s view, when people expect to live longer, the amount of money they put aside to finance retirement increases, and these savings depress interest rates. This savings glut has increased demand for safer assets such as Treasury securities. Additionally, productivity gains have decreased to 1% a year since the recession, from 2–3% in the previous decades.