On Tuesday, Fed Governor Lael Brainard downplayed past talk of numerous rate hikes from the federal reserve and suggested that he Fed may “not have much more” to do in terms of rate hikes. “In light of recent policy moves, I consider normalization of the federal funds rate to be well under way,” Brainard said.

Today, speaking before Congress, Janet Yellen built upon Brainard’s earlier comments, but simultaneously suggested that there will be “gradual rate hikes” over “the next few years,”  and hinting that many more rate hikes won’t be necessary because “the neutral rate is low by historical standards.”

Markets took this to mean — probably correctly — that the Fed is moving in a more dovish direction. 

The “Neutral Rate” Canard 

Note that both announcements are based on the idea that the “neutral rate” is unusually low, so while a target rate of 1.5 percent may seem quite low by historical standards, it’s not really low. It is near the neutral rate — also known as the “natural rate.”

In other words, the “natural rate” has fallen below where it was in the past, so now, the interest rates we saw in the days of yore — those around 3 per cent or 5 percent — would today be much too high. 

Bloomberg explained a bit more of the Fed’s logic here last year: 

When Fed Chair Janet Yellen wants to explain why the Fed is keeping rates so low, she cites the natural rate. At the press conference following the FOMC’s June meeting, she said the neutral interest rate—which is essentially synonymous with the natural rate—“is quite depressed by historical standards.” She added: “I think all of us are involved in a process of constantly reevaluating where is that neutral rate going.”

Politically speaking, identifying this “natural rate” as being very low allows the Fed to create the perception that its very-low target rates aren’t really all that stimulative at all. They’re practically neutral! Just look at the natural rate, they’ll tell us.