Economists are increasingly revising upwards their estimates for the "neutral" interest rate, which is the theoretical rate that neither stimulates nor restricts economic growth. This shift is influenced by factors such as the ongoing artificial intelligence boom driving significant capital expenditure, particularly in data centers, and persistently high inflation. Federal Reserve Chair Kevin Warsh has acknowledged this, noting that current U.S. monetary policy shows little sign of impacting loan or credit growth, and financial conditions remain loose, suggesting the neutral rate may be higher than previously assumed.
The Federal Reserve recently raised its benchmark interest rate to the 3.75%-4.00% range, with projections indicating the policy rate could reach 4.00%-4.25% by the end of 2026. This hawkish stance, driven by an energy shock from the U.S.-Israeli war with Iran and the AI investment boom, challenges the long-held assumption among many Fed officials that rates were already slightly restrictive. Futures markets now fully price in two rate rises by March and a third partially priced over the next 12 months, with the policy rate not expected to fall below 4% through 2028.
Historically, the median of quarterly Fed policymaker forecasts for the long-term nominal policy rate, a proxy for neutral, has fluctuated. It currently stands at 3.1%, up from 2.4% in 2022, and was as high as 3.8% in 2015. Fed models suggest the real neutral rate ("R-star") is between 1.0% and 1.65%. With a 2% inflation target, this implies a nominal neutral rate close to the current rate at the upper end of that range. However, real Fed policy rates, adjusted for prevailing inflation, are still effectively zero, indicating that policy may still be stimulating growth despite other economic indicators. Goldman Sachs Research also revised up its 2026 GDP growth forecast to 2.3% and 2027 to 2.4%, while lowering unemployment rate forecasts to 4.1% for 2026-2028.
