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Navigating With The 'R Star'

Mar. 07, 2019 2:47 PM ET2 Comments
720 Global profile picture
720 Global


  • Fed Monetary Policy rests on an obscure metric called R-Star, or R*.
  • The Fed has made an abrupt U-turn in policy - why?
  • Let's reflect on history and try to answer the question.

"It's difficult to make predictions, especially about the future." - Niels Bohr

On Nov. 28, 2018, Federal Reserve Chairman Jerome Powell gave a speech at the Economics Club of New York that sent the stock market soaring by over 2%. The reason cited by market pundits was the reversal of language he used a few weeks earlier suggesting that the Fed still had several more rate hikes ahead. In other words, he softened that tone and seemed to imply that the Fed was close to pausing.

By most accounts, Fed policy remains very accommodative but the "Powell Pivot", which began in late November and continues to this day, hinges on an obscure metric called R-Star, or R*. Even though interest rates have been held low and vast amounts of liquidity force fed into markets through quantitative easing, the idea that interest rates should not rise much further presents a unique dilemma for the Fed. Rationalizations for their guidance hinges on R*. Before going in to details about this important measure, let us reflect on history.

Doomed to Repeat It

Here's a quote from Federal Reserve Chairman Ben Bernanke on Jan. 17, 2008, in response to Congressman John Spratt, ranking member of the House Budget Committee:

Well, we currently see the economy as continuing to grow, but growing at a relatively slow pace, particularly in the first half of this year. As the housing contraction begins to wane, as it should sometime during this fiscal year, the economy should pick up a bit later in the year.

The table below was a document used on an unscheduled Fed conference call on Jan. 9, 2008, to discuss deteriorating credit conditions in the U.S. economy. At that time and unbeknownst to the Fed, the economy slipped into recession the prior month, yet the Fed's commentary and one- and two-year outlook for

This article was written by

720 Global profile picture
720 Global has joined forces with Lance Roberts at Real Investment Advice. We publish research on macroeconomic trends, market dynamics, investment opportunities, and a host of topics designed to help individuals and professionals navigate the markets. For more information please message us or visit us at www.realinvestmentadvice.com

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Comments (2)

Excellent article!

The author is quite right that the economy is a too complex beast for even the best Fed's models, and the Feds wizards have poor record in that respect. But, should we rely only on the market forces, as the author seems to believe: "A more reliable approach to monetary policy would be to allow markets to dictate prices. Billions of buyers and sellers, borrowers and lenders, who transact every day are collectively better informed than the small group of unelected and unaccountable figureheads at the Fed"

I think not, for the collective wisdom of the market is subject to too strong positive feedback and hence, to too much instability. It is enough to look at the pre-Fed recessions frequency and dept to see what we will have.

So, the matter is in finding the right balance, and I here fully agree with the author that the Fed used too much and for too log its highly addictive medicine (cheap money). Now we are addicted and it can not be withdrawn without significant harm. Unfortunately, the positive effects of the cheap money medicine are diminishing with its abuse (see Japan) and the negative effects (assets price inflation, bubbles, dept levels and social disparity) keep multiplying.

One contributor very astutely said that the Fed got us in Hotel California: You can check there at any time, but you can never leave.
Salmo trutta profile picture
@iyanachk : "The author is quite right that the economy is a too complex beast for even the best Fed's models"

Interest is the price of loan-funds. The price of money is the reciprocal of the price level. Therefore AD can never be driven by the manipulation of short-term interest rates at the front end of the yield curve.

And R * , the "Wicksellian Natural Rate of Interest" is fictional.

Investment “hurdle rates” are idiosyncratic. Business expenditures depend largely on profit-expectations, and favorable profit-expectations depend primarily on cost/price relationship of the recent past and of the present. Cost/price relationships are crucial, and they are particular; they cannot be adequately treated in terms of broad-aggregates or statistical weighted “averages”.

Macro reflects rates-of-change in the flow-of-funds - second derivatives. Macro is kid's stuff.

-Michel de Nostredame
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