24/7 Wall St.

Another day, another Fed president speaking. St. Louis Federal Reserve President James Bullard gave a speech called “One Equation to Understand the Current Monetary Policy Debate” at the Association for University Business and Economic Research at the 2016 Fall Conference in Fayetteville, Arkansas.

24/7 Wall St. has seen many Fed presidents speak about the need and desire to raise interest rates. It remains up for debate over how severe those hikes need to be, but the view from this Fed president is that interest rates are likely to remain low for quite some time — perhaps for years.

Bullard deconstructed a Taylor-type rule to help explain the current monetary policy debate. Bullard also used this to explain the St. Louis Fed’s projected policy rate path of 0.63% over the forecast horizon.

With unemployment and inflation near their long-run values, the recommended policy rate from a Taylor-type rule depends mostly on the real (inflation-adjusted) safe rate of return. Bullard further added that real safe rates of return are exceptionally low and are not expected to rise soon. In short, the policy rate should be expected to remain exceptionally low over the forecast horizon.

Monday’s speech by Bullard said:

The current policy rate setting is just 38 basis points, extraordinarily low by postwar historical standards. The FOMC is considering raising the policy rate to a somewhat higher level,” he said, adding that “the St. Louis Fed’s rate path projection is much flatter than the rest of the Committee.

The bottom line: Low interest rates are likely to continue to be the norm over the next two to three years.

Two factors were cited for why there is downward pressure on real safe rates of return. One is a low productivity-growth regime, and the other was a high liquidity-premium regime, wherein investors are willing to pay premium prices for safe assets like government debt. Bullard’s speech said:

Real rates of return on safe assets have been declining relative to the real return on capital in the U.S. for several decades. … Real safe rates of return are exceptionally low at present and are not expected to rise soon. This means, in turn, that the policy rate should be expected to remain exceptionally low over the forecast horizon.

What is interesting here, and rather different from many Fed president speeches, is that this equation was discussed around his Taylor-type rule. That full data are available.