The R-Star Reality: Low Rates Forever?
On 25 August 2025, New York Federal Reserve Bank President John C. Williams addressed an audience in Mexico City with a message that resonated far beyond the confines of central banking circles. He argued that the neutral interest rate, or r-star, remains anchored close to its pre-pandemic level of around half a per cent. Despite high inflation in recent years, aggressive tightening, and subsequent cuts, Williams insisted that the long-run equilibrium rate has not shifted. “The era of low r-star is far from over,” he declared.
For markets, the implications are significant. If the neutral rate really is this low, then policy remains restrictive even after recent rate reductions. That means the cost of capital is tighter than headline levels suggest, with knock-on effects for bond yields, valuations and currencies. It also raises the prospect that the Fed will once again collide with the effective lower bound in the next downturn, forcing policymakers back towards unconventional tools such as quantitative easing.
Williams’s reasoning rests on structural forces that he argues remain intact. Demographics, including longer lifespans and falling birth rates, continue to elevate global savings while curbing demand for investment. Productivity growth, once the motor of higher returns on capital, has slowed sharply, limiting profitable opportunities. And the legacy of the global savings glut, reinforced by investor demand for safe assets since the financial crisis, keeps the equilibrium rate pinned down. None of these dynamics, he stressed, have been overturned by the pandemic.
Central to his credibility is his reliance on the Holston-Laubach-Williams (HLW) model, which he co-authored. Originally developed as the Laubach-Williams framework in 2003 and later updated with Kathryn Holston in 2017, the model has become the benchmark for estimating r-star. By inferring the neutral rate from the observed relationship between output, inflation and interest rates, it seeks to capture the underlying structural drivers that markets often miss. For Williams, this is not simply a technical preference — it is his intellectual legacy. He openly contrasts it with market-based measures, which he derides as a “hall of mirrors,” distorted by risk premiums and sentiment rather than fundamentals. That scepticism matters for investors: policy may be guided by HLW’s slow-moving structural compass rather than the volatility of market pricing.
The distinction Williams draws between cyclical fluctuations and structural anchors is crucial. Robust demand, resilient investment and stubborn inflation, he maintains, reflect temporary late-cycle dynamics and fiscal stimulus, not a permanent shift in equilibrium. To mistake heat for structure, he cautioned, would mislead both policymakers and markets.
For bond traders, the message is sobering. A persistently low r-star caps the long-term trajectory of yields, shapes the curve, and means easing cycles are more likely to run into the lower bound. Williams’s Mexico City speech offered a reminder that, in monetary policy, the deepest currents are structural, not cyclical — and that financial markets ignore them at their peril.
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