Another likely reason for the decline in the neutral rate is the emergence of the U.S. as chief supplier of safe assets to the world. In an increasingly globally connected world, the search for safety and return occurs globally—meaning that low rates in one country can quickly impact interest rates in other countries. Robert Hall of Stanford University and the Hoover Institution argues that the representation of risk-averse foreign investors in U.S. financial markets has increased and that this trend has contributed to downward pressure on the neutral real rate.
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I am strongly persuaded by arguments that aging demographics in advanced economies, a decline in productivity growth and the continued emergence of the U.S. as a source of safe assets have all contributed to the decline in the neutral rate.

In my view, the paper reaches five major conclusions---conclusions that I find myself broadly in agreement with:

There are many factors that influence the level of the equilibrium real short-term interest rate. Real potential GDP growth may be one factor, but the real equilibrium rate is also affected by financial conditions, uncertainty and risk aversion, financial market performance (e.g., bubbles and busts) and the degree of restraint exerted by the stringency of banking and financial market regulation.

There is little evidence supporting the so-called secular stagnation view that the equilibrium real short-term rate will persistently remain near or below zero.

The equilibrium real short-term rate is non-stationary. Thus, it will not necessarily revert back to some long-run average value.

U.S. and global markets are integrated to a significant degree. As a result, the equilibrium real short-term rates both here and abroad will tend to move together. This seems especially germane in the current environment in which very low long-term government bond yields in Europe and Japan appear to have been an important factor in pulling U.S. long-term yields lower over the past year or so.

Given the uncertainties about the current and future levels of the equilibrium real short-term rate, an inertial policy rule may lead to better outcomes. As a consequence, the process of normalization of monetary policy should proceed cautiously, with short-term interest rates more likely to rise only gradually toward the equilibrium real short-term rate.
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My point estimate is that the longer-run value of the federal funds rate is 3 percent, well below its long-run historical level of 4 percent. At the same time, I also have little confidence about the accuracy of this specific estimate. So you see that I come out in a very similar place as the authors of this years Monetary Policy Forum paper. They suggest that the long-run equilibrium real federal funds rate might be in the range of 1 to 2 percent. Add on 2 percent inflation, you end up in just about the same place as my current long-term 3 percent nominal federal funds rate point estimate.

And I would say even if you consider our forward guidance we put in place in march, the committee indicated that even after we think the time has come to raise rates, that we think it will be some considerable time before we move them back to historically normal levels, and that reflects -- well, different people have different views, but to my mind, it in part reflects the fact that headwinds holding back the recovery do continue. Productivity growth has been slow, and of course, we need to be cautious to make sure that the economy continues to recover.

Even when the economy gets back on track, it doesn't mean that these headwinds will have completely disappeared. And in addition to that, productivity growth is rather low. At least that may not be a permanent state of affairs, but it's certainly something that we have seen in the aftermath. We'll -- we've seen it during most of the recovery. That's a factor that I think is suppressing business investment and will work for some time to hold interest rates down. These concerns and these factors are related to what economists are discussing, including secular stagnation. The committee -- you know, when it thinks about what is normal in the longer run, the committee has recently slightly reduced their estimates of what will be normal in the longer run. It -- the median view on that is now something around 3 and 3 1/4 percent, but we don't really know. But it's the same -- the same factors that are making the committee feel that it will be appropriate to raise rates only gradually, they're some of the same factors that figure in the secular stagnation.

My view is that the neutral federal funds rate consistent with trend growth is currently very low. That’s one reason why the economy is not growing very fast despite the current accommodative stance of monetary policy.  Although the neutral rate should gradually normalize over the long-run as economic fundamentals continue to improve and headwinds abate, this process will likely take many years.  In the meantime, the federal funds rate level consistent with the Committee’s objectives of maximum sustainable employment in the context of price stability will likely be well below the long-run level.

Committee participants generally believe that because the headwinds to recovery will abate only gradually, achieving and maintaining maximum employment and price stability will require a patient policy approach that involves keeping the target for the federal funds rate below its longer-run normal value for some time.

Committee participants generally believe that because the headwinds to recovery will abate only gradually, achieving and maintaining maximum employment and price stability will require a patient policy approach that involves keeping the target for the federal funds rate below its longer-run normal value for some time.

A large majority of the participants of the FOMC, including voting and nonvoting members, who are asked to describe their own assessment of optimal policy, the large majority of them estimate that the appropriate targets of the federal funds rate at the end of 2016 will be around 2 percent, even though at that time the economy should be close to full employment, according to our best -- best projections.

The reason for that -- there may be possibly several reasons, but we did discuss this in the committee today. The primary reason for that low value is that we expect that a number of factors, including the slow recovery of the housing sector, continued fiscal drag, perhaps continued effects from the financial crisis, may still prove to be headwinds to -- to the recovery. And even though we can achieve full employment, doing so will be done by using rates lower than sort of the long-run normal.

So, in other words, in economics terms, the equilibrium rate, the rate that achieves full employment, looks like it will be lower for a time because of these headwinds that will be slowing aggregate demand growth. So that's why we expect to see growth at -- I mean, rates at unusually low level.

I imagine it would take a few more years after that to get to the 4 percent level. I couldn't be much more precise than that. I mean, we're already, obviously, stretching the bounds of credibility to talk about specific projections for 2016. But I think you would expect to see the rates would gradually rise for the two or three years after 2016 and ultimately get to 4 percent.

Some observers have attributed the bubbles observed in some asset prices in recent years to a decades-long downward trend in real interest rates. In this view, the decline in interest rates has caused investors to reach for yield by purchasing riskier assets with higher returns, driving the prices on riskier assets above fundamental values... From my perspective, the decisions the central banks were making about their policy rates were shaped by the underlying determinants of the balance of saving and investment, including, in the past decade or so, the high saving propensities of the newly emerging Asian economies and the sluggish rebound in investment globally after the recession early last decade. Nonetheless, it is important that we understand the reasons for the decline in average real rates and whether low rates are likely to persist--and that very tough problem is the extra credit assignment. For one thing, as the economic expansion gains traction and central banks back off the current highly accommodative stance of policy, policymakers will need to understand how the longer-term trend in real rates has influenced the point at which the policy rate becomes restrictive...

The sustainable or long-run trend growth rate of the economy is an important benchmark in calibrating the stance of monetary policy. In general, economies that grow faster exhibit real, or inflation-adjusted, interest rates that are somewhat higher than those of slow-growing economies. Monetary policymakers must be cognizant of that fact in setting the target for the fed funds rate. Failure to do so would likely result in the creation of either too much or too little liquidity, leading to too much or too little inflation or perhaps even deflation.

One issue concerns the possibility and potential consequences of a shift in risk perceptions in international financial markets. There are now numerous indications that risk premiums are notably low—in the U.S. and also globally....

The low long-term rates and low risk premiums that have prevailed in financial markets over the last several years mean that overall financial conditions have been notably more accommodative than suggested by the current level of the real federal funds rate. Given that, a shift in risk perceptions would tend to push longer-term rates and credit spreads up, restraining demand worldwide.

An “asymmetric policy tilt” seems appropriate given the risks to inflation.  However, the complexities of the current situation—including uncertainties concerning the behavior of output and employment, as well as growing downside risks to economic growth and the possibility that the neutral level of the funds rate has been lowered by a productivity slowdown—make it appropriate for policy to retain considerable flexibility in responding to emerging data.  The statement thus emphasizes that “Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.”  What all of these considerations add up to is that the stance of monetary policy will undoubtedly need to be adjusted in ways that are dictated by shifts in our forecasts for inflation, output, and employment in light of incoming data. 

The fact that official purchases of financial assets are determined by different factors than those influencing private investors suggests that we would probably see a somewhat different combination of capital flows, exchange rates and interest rates in the absence of official intervention...

If the prevailing patterns of capital flows were to exert downward pressure on interest rates and upward pressure on other asset prices, they would contribute to more expansionary financial conditions than would otherwise be the case. Among other things, this outcome complicates our ability to assess the present stance of monetary policy. It can change how monetary policy affects overall financial conditions and the economy as a whole.

Such complications can mask the effect of other forces that might otherwise find expression in risk premiums or interest rates: forces, for example, associated with the concern about fiscal sustainability in the United States or the sustainability of our external imbalances...