The natural rate of interest is the rate at which the economy operates without a risk of inflation or deflation. In other words, it is the rate of interest which ought to be the policy goal of the Fed. Paul Krugman reports on a study which shows that the natural rate of interest has varied over time and that it is currently around zero. This suggests the current Fed inflation target of 2% may be too low. The real interest rate is the nominal rate of interest minus the inflation rate. A 2% target rate does not provide much room for the Fed to lower the real interest during a recession.
The Fed has been accused of using monetary policy to keep interest rates too low. This study suggests the zero rate of interest is exactly what the economy requires. That is, it is the natural rate of interest.
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