R-stars Across the Atlantic—The Role of Policy Expectations

We study how policy expectations affect the estimated natural rate of interest (r*) for the United States and the euro area. To discipline policy expectations, we incorporate information on future policy rates and long-term yields in episodes when the Fed and ECB provided forward guidance. For the post-Covid period, we find that r* rises much more than in an otherwise standard specification that omits yield-curve observables. By implication, the post-Covid tightening of the monetary policy stance was not nearly as large as standard r* models imply, which helps explain why economic activity did not slow much when nominal policy rates were raised dramatically in 2022 to fight inflationary pressures. Yield-curve information pins down anticipated policy innovations and alters r* estimates and, thus, the monetary policy stance.