Central bankers spend an extraordinary amount of time steering toward a number they cannot see.
That number is r∗r^*, the equilibrium interest rate that keeps an economy growing near potential while inflation rests at target. Policy below it is stimulative. Policy above it is restrictive. The complication is that r∗r^* cannot be observed directly and tends to become clearest only after the economy has already driven past it.
The question facing the European Central Bank is therefore not simply whether it should deliver the widely anticipated 25 basis point increase on September 10. The more consequential issue is whether the euro area’s neutral rate has moved higher, leaving the ECB with more room to tighten before monetary policy begins applying the brakes.
Takeaways by Dark Side of the Boom™
Goldman estimates the euro area’s nominal neutral rate near 2.7%, although the plausible range remains unusually wide.
Growth above potential, historically low unemployment and resilient credit demand suggest current policy is not particularly restrictive.
Higher equity prices and a weaker euro have offset much of the tightening delivered through interest rates.
The evidence lowers the hurdle for the ECB to move beyond Goldman’s 2.5% terminal forecast and eventually settle above its current 2% long run estimate.