In a preface to Naked Lunch, William S Burroughs said the title refers to “a frozen moment when everyone sees what is on the end of every fork.”
The equivalent for economists is an R-star epiphany. Here’s a good example from Joe Lupton and Dan Weitzenfeld of JPMorgan:
A model to make Rube Goldberg proud. The [R*] empirical models, with varying degrees of added complexities, all yield a similar result. With each iteration, implausible results in one area are corrected only to generate new implausible results elsewhere. These complex structural economic models have such wide standard errors that one would be equally well served in using the crudest of simple autoregressive models for fitting the observed data.
Call it what you like — the neutral interest rate, the natural real rate, the long-run equilibrium rate, the rate that would support the economy at maximum output while keeping inflation constant — R* doesn’t exist. There’s no such thing.
That’s awkward for monetary policy committees that frame decisions around some measure of R*. The benchmarks they use rely on academic methods that are “uncertain at best and useless or misleading at worst,” JPMorgan says. And crap data gives them “little more than confirmations of existing priors.”
It’s mostly a garbage in, garbage out problem:
The R* models rely on their theoretical foundations for an empirical framework. However, with each addition of a new equation comes a new unknown. Ultimately, these simple models are asked to jointly triangulate not only a time series for R*, but also seek to identify potential growth, the output gap, and the neutral rate of unemployment. All of this is done using only a few actual economic inputs.
Lupton and Weitzenfeld offer no solutions, only condemnation. R-star’s uselessness on both a conceptual and practical level, they say, “points to central banks feeling around the in dark”.
JPMorgan’s full note is outside the client paywall and is well worth your time. Consider it a companion piece to a more R-star tolerant note from JPMorgan chief economist Bruce Kasman published just last month.
Further reading:
— When you wish upon R*
— There’s no such thing as R*
Source: Economy - ft.com
