As the onset of balance sheet normalization comes closer over time, the effect of the Federal Reserve’s balance sheet actions on the term premium will gradually diminish. This means that the size of the federal funds rate adjustment should also diminish over time. 6  BIS central bankers’ speeches  rate has fallen, as I believe it has, then the entire trajectory of short-term rates implied by Taylor 1999 shifts down and this pushes back the liftoff date implied by Taylor 1999 significantly. So how strong is the evidence that the neutral real rate has fallen significantly at least in the short term? First, and most importantly, if the neutral real rate were really 2 percent, then the U.S. economy should be growing faster11 as monetary policy would be extraordinarily stimulative right now. But, if that is the case, then why do we see such a lackluster economic performance? Thomas Laubach and John Williams have devised a means of estimating how the equilibrium real interest rate varies over time based on how the economy has actually performed. The estimate generated by their model for the first quarter of 2012 is 0.3 percent.12 Second, we can identify good reasons why the neutral real rate is depressed currently. The channels through which monetary policy stimulates the economy are weaker than normal right now.13 Monetary policy works through its effect on financial conditions that influence economic activity.
These problems can be mitigated if there is a certain underlying inflation rate in the economy. Underestimating the significance of monetary policy and exchange rate developments One problem when criticizing monetary policy with reference to the current economic situation is that one does not take into account the fact that the current strong Swedish economy is of course to a large degree due to the monetary policy that has been conducted. It is a little like taking medicine in connection with an illness and when cured drawing the conclusion that it was unnecessary to take the medicine. On this point I feel that the events of spring 2015 are a good illustration. The ECB had announced in January that it intended to buy securities over slightly more than a year to come for the equivalent of SEK 10,000 billion (around 2.5 times the size of Swedish GDP). This is indeed a very substantial monetary policy intervention. Within the course of just a few weeks the krona exchange rate appreciated significantly against the euro, from almost 9.65 krona per euro to just over 9.10. This was in itself a large appreciation of almost 6 per cent, but the real danger lay in the fact that it could have been much worse. During 2014 and up to spring 2015 the US dollar and the British pound sterling had appreciated by between 15 and 25 per cent against the euro.