The Federal Reserve Bank of St. Louis is changing its characterization of the U.S. macroeconomic and monetary policy outlook. An older narrative that the Bank has been using since the financial crisis ended has now likely outlived its usefulness, and so it is being replaced by a new narrative. The hallmark of the new narrative is to think of medium- and longer-term macroeconomic outcomes in terms of regimes. The concept of a single, long-run steady state to which the economy is converging is abandoned, and is replaced by a set of possible regimes that the economy may visit. Regimes are generally viewed as persistent, and optimal monetary policy is viewed as regime dependent. Switches between regimes are viewed as not forecastable.

The upshot is that the new approach delivers a very simple forecast of U.S. macroeconomic outcomes over the next 2 ½ years. Over this horizon, the forecast is for real output growth of 2 percent, an unemployment rate of 4.7 percent, and trimmed-mean PCE inflation of 2 percent. In light of this new approach and the associated forecast, the appropriate regime-dependent policy rate path is 63 basis points over the forecast horizon.

While the real return to short-term government debt is low today, the real return to capital does not appear to have declined meaningfully. For this reason we prefer to interpret the low real rate of return on short-term government debt not as reflecting low real returns throughout the economy (as in a simple New Keynesian model), but instead as reflecting an abnormally large liquidity premium on government debt. It is this liquidity premium which is the fundamental factor. We sometimes refer to this conception of the low value of the real return on short-term government debt as r† (“r-dagger”) to distinguish it from the more commonly discussed r* (“r-star”).