R-star (r*) is the neutral real interest rate — the inflation-adjusted policy rate at which monetary policy neither stimulates nor restrains an economy running at full employment with stable inflation. It is the unobservable anchor central banks aim toward, estimated rather than measured, and shifts slowly with potential growth and demographics.
How it works
R-star is defined as the short-term real rate that closes the output gap at target inflation over the medium run; it cannot be observed directly and is inferred from models such as Holston-Laubach-Williams that filter it out of growth, inflation, and rate data. Adding expected inflation gives the nominal neutral rate. Policy is stimulative when the real policy rate sits below r*, restrictive when above.
Why it matters now
Whether r-star has durably risen post-pandemic — pushed up by fiscal deficits, defence and energy capex, and reshoring — is the central rates debate of 2025-2026, since a higher r* means the Fed's terminal rate and long-end yields settle structurally above the 2010s lows.
Example
Holston-Laubach-Williams estimates put US r-star near 0.5% in the late 2010s, far below the ~2.5% prevailing before the 2008 crisis. Macro models cited in our briefings imply a modest 0.25–0.50 percentage-point rise since 2018, lifting the implied nominal neutral rate toward roughly 3% when paired with 2% target inflation — consistent with the FOMC nudging its longer-run dot up from 2.5% toward 3% across 2024-2025 SEP rounds.
Frequently asked
- What is r-star?
- R-star (r*) is the neutral real interest rate at which monetary policy neither stimulates nor restrains an economy at full employment with stable inflation. It is unobservable and must be estimated from data on growth, inflation, and rates. Central banks treat it as the gravitational anchor for the policy rate over the medium run.
- Why does r-star matter for interest rates?
- R-star matters because it sets the destination for policy rates: a higher neutral rate means the central bank's terminal rate and long-end bond yields settle structurally higher. If r* rose from 0.5% to 1%, the nominal neutral rate climbs toward 3%, recalibrating what counts as restrictive policy and where fair-value yields sit across the curve.
- How is r-star estimated?
- R-star is estimated by filtering it out of observed macro data using statistical models, most prominently the Holston-Laubach-Williams framework run by the New York Fed. The model jointly extracts trend growth
Glossary · potential growth rate
Potential growth rate is the maximum pace at which an economy can expand output without generating inflationary pressure, set by the supply-side trend of labour force growth, capital accumulation, and total factor productivity. It is unobserved and must be estimated, defining the speed limit around which the output gap is measured.
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Glossary · output gap
The output gap is the percentage difference between an economy's actual output and its potential output — the level sustainable without generating inflationary pressure. A positive gap signals demand running hot; a negative gap signals slack. It is a central, if unobservable, input to monetary policy and Phillips-curve inflation forecasts.
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Glossary · carry
Carry is the income earned (or paid) for holding a position over time, independent of price change — the coupon, yield, or interest-rate differential captured while waiting. Positive carry pays you to hold; negative carry costs you. It is the return that accrues if nothing moves.
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- Has r-star risen since the pandemic?
- Many macro models suggest r-star has risen modestly post-pandemic — roughly 0.25 to 0.50 percentage points since 2018 by some estimates — driven by larger fiscal deficits, defence and reshoring capex, and energy investment. The FOMC reflected this by lifting its longer-run rate projection from 2.5% toward 3% across 2024-2025, though the increase remains contested.
- How does r-star differ from the terminal rate?
- R-star is the long-run neutral real rate
Glossary · r* (natural rate of interest)
r* is the real short-term interest rate consistent with output at potential and stable inflation — the rate at which monetary policy neither stimulates nor restrains the economy. It is unobservable, must be estimated, and anchors how restrictive any given policy stance actually is.
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