Fed Officials Split Deeply on Long-Term Interest Rate Strategy

After lowering interest rates by more than a full percentage point, Federal Reserve officials are now debating where the easing cycle should end and the divide inside the central bank is wider than it’s been in years. Over the past 12 to 18 months, policymakers’ projections for the ultimate destination of rates have spread out more than at any point since 2012, when the Fed first began publishing its estimates. That widening gap is fueling an unusually open disagreement over whether to deliver another rate cut next week, and if so, what comes afterward.

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Fed Chair Jerome Powell has openly acknowledged that members of the rate-setting committee hold “strongly differing views” about which of the Fed’s dual mandates stable inflation or maximum employment should take precedence right now. The central issue is whether the U.S. economy still needs extra support to keep the labor market healthy, or whether rising prices and the risk that tariffs could push inflation even higher mean it’s time to proceed more cautiously.

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That debate leads directly to a broader, more theoretical question: what level of interest rates neither stimulates the economy nor restrains it? This rate — the so-called “neutral” level represents the point at which the Fed would ultimately stop cutting. And at the moment, policymakers are struggling to pin down where that equilibrium lies.

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All Over the Place’
When the Fed last released its projections in September, 19 officials put forward 11 different estimates of the neutral rate, ranging from 2.6% to 3.9%. That upper figure is roughly where policy rates currently stand.

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“We have people all over the place,” said Stephen Stanley, chief U.S. economist at Santander. While disagreement is nothing new, he noted the present range is the widest in years. Stanley also argues that these estimates are becoming more consequential as the benchmark rate bumps against the higher end of the projected neutral band. “Each successive cut gets harder and harder,” he said, especially for the Fed’s more hawkish members.

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Recent comments from policymakers highlight this tension. Philadelphia Fed President Anna Paulson said on Nov. 20 that the competing risks of softer employment and higher inflation combined with the possibility that rates are already near neutral leave her approaching the December meeting with extra caution. “Monetary policy has to walk a fine line,” she said. “Each rate cut brings us closer to the level where policy flips from restraining activity to providing a boost.”

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The neutral rate often referred to as r-star in economic models is also called the natural rate. It cannot be directly observed, only estimated, and economists have debated its usefulness for more than a century. Some, like John Maynard Keynes, questioned whether it’s even a helpful concept, but nearly all modern central bankers consider it essential.

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New York Fed President John Williams, one of the leading experts on the topic, says the idea is central to “monetary theory and practice.” He has warned that misjudging changes in neutral rates or in the natural rate of unemployment can lead to serious policy mistakes, pointing to the inflation surge in the 1960s and 1970s as an example. In general, neutral rates are thought to evolve slowly in response to demographic shifts, technological progress, productivity growth, and changes in debt levels that influence savings and investment trends.

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Alongside the lack of consensus about where neutral currently sits, Fed officials also disagree about its direction.

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Minneapolis Fed President Neel Kashkari believes broad adoption of artificial intelligence will significantly strengthen productivity growth, pushing neutral rates higher as new investment opportunities raise the demand for capital.

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By contrast, Fed Governor Stephen Miran appointed by former President Donald Trump argues that recent policy choices should also factor into the debate. In his first policy speech, Miran contended that tariffs, tighter immigration rules, and tax cuts have collectively depressed the neutral rate, at least temporarily. Because of that, he argues the Fed should cut rates more aggressively to avoid economic damage.

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Williams, however, is skeptical of incorporating short-term policy shifts into neutral-rate estimates. He maintains that large-scale global forces, such as aging populations, are keeping neutral rates near historically low levels.

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Before the pandemic, when inflation was subdued and interest rates hovered near zero, policymakers were mostly aligned on where neutral rested. But the price surge that followed, combined with uncertainty surrounding trade policy, immigration, and the economic impacts of AI, has caused estimates to diverge once again.

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The issue is poised to become even more complicated in 2026, when the Fed faces a leadership transition. Trump has pledged to appoint a new chair who favors lower rates, and he may also shape the broader policymaking team. New appointees may share Miran’s view that the neutral rate is currently lower and argue for easier policy as a result.

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Because r-star cannot be directly observed much like astronomers infer dark matter some Fed officials prefer to judge it based on economic outcomes. St. Louis Fed President Alberto Musalem points to low default rates as evidence that financial conditions remain supportive. Cleveland Fed President Beth Hammack notes that narrow credit spreads suggest monetary policy is only mildly restrictive, if at all.

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Still, interpreting market signals is fragile. Some policymakers view the 10-year Treasury yield, hovering near 4%, as proof the economy isn’t being constrained by tight financial conditions. Others counter that long-term yields reflect growth expectations and global demand for safe assets, making them unreliable guides to the neutral rate.

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Given the uncertainties clouding the outlook, the divide over neutral is unlikely to narrow when the Fed publishes its updated projections next week. Instead, real-time data particularly labor market and inflation readings will dictate the Fed’s decisions, said Patrick Harker, the recently retired Philadelphia Fed president.

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The neutral rate may be “a useful conceptual tool,” Harker said, “but it’s only a tool. I don’t ever remember a case where everybody sat around and the entire conversation was, what is r-star?”

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