On Tuesday, at an ECB event in Frankfurt, Adriana Kugler said she doesn’t know the location of the neutral rate. What she does know — or, more aptly, what she claims to know — is that the Fed funds rate is currently “way above it.”

I’ve been over this — “this” being the logical fallacies Fed officials regularly traffic in when discussing r-star — but I’m compelled to revisit the issue in light of the suddenly vociferous debate about what the Fed should do at its November policy meeting in consideration of a jobs report which, without mincing words, partially destroyed the rationale for last month’s upsized rate cut.

The funds rate is “restrictive” or not relative to a hypothetical equilibrium rate which prevails when the dual mandate’s in perfect balance and the economy’s expanding at or near potential. As it relates to monetary policy, the terms “restrictive” and “loose” have no meaning without reference to that hypothetical rate which, by virtue of being hypothetical, isn’t observable.

On first principles, this makes very little sense if it makes any sense at all. As I patiently explained last year,

As a practical consideration, the neutral rate’s pretty useless. The idea that it’s possible to geolocate that rate and then manage policy dynamically to sustain the economy somewhere near the corresponding equilibrium, is fanciful. That rate, to the extent it exists, is at least a little bit different for every state, city, town and hamlet. Something’s always going to be out of balance somewhere. Maybe you can achieve a result that looks like balance at the aggregate, economy-wide level, maybe you can’t, but the odds of mistakes are high, and the unintended consequences could be disastrous.

So there’s that. To even have this discussion is to traffic in nonsense. Alas. C’est la vie.

In theory, policymakers know they’re close to the neutral rate when the labor market’s near full employment and prices are a semblance of stable. (Note that “stable”‘s deliberately a misnomer: Policy is designed to deliver 2% annual inflation, because an economy with no inflation is an economy at risk of deflation and deflation’s bad.)

The rationale for last month’s 50bps Fed cut went something like this. Inflation’s come down a lot from the highs and the unemployment rate’s risen a lot from the lows, and while there are a whole host of factors which can explain that conjuncture, one of them’s surely restrictive monetary policy. We want to stop the unemployment rate from rising any further, so we need to make policy less restrictive, and we probably have ample room to do that because by appearances anyway, current policy is very (severely, even) restrictive.

There are a couple of problems with that not least of which is that even before the September jobs report, it was the furthest thing from obvious that policy was, in fact, restrictive, let alone severely so. Americans were still spending, the economy was growing above potential and core inflation remained more than a full percentage point above target. At the same time, stock prices were at or near record highs, credit spreads were close enough to record tights and financial conditions, as measured by several composite gauges including the Fed’s own metric, were looser than they were prior to the onset of rate hikes in early 2022.

Speaking of the Fed’s own metrics, the figure shows three Fed estimates of the neutral rate: John Williams’s well-known model, a Richmond Fed model and the NY Fed’s DSGE model. (Note: Those are actually r-star estimates, so you have to add 2% to get nominal neutral, shown below.)

What do you see? A bunch of meaningless lines? You’re not wrong! Jokes aside, the point is that the current funds rate (orange line) isn’t meaningfully restrictive compared to the current estimate of neutral derived from the Richmond Fed model (yellow line) nor the forward-looking estimate using the DSGE model (the white line). The green-shaded area shows Fed officials’ subjective assessment of the long run neutral rate from the September SEP (i.e., the long run dot).

Hat tip to JonesTrading’s Mike O’Rourke, who flagged this two evenings ago. His point was that the funds rate is only restrictive by reference the to the HLW estimate. On the other two estimates, the funds rate is at or around neutral currently. As O’Rourke noted, that’d be consistent with the incoming data which shows a softer (but not necessarily soft) labor market and headline inflation inclined to loiter just above target.

Since neutral isn’t observable, policymakers have to impute it, and the argument for Kugler’s contention that policy’s “way above neutral” depends very much on the notion that the US labor market’s decelerating rapidly. September’s jobs report suggested exactly the opposite. It suggested the labor market’s re-accelerating, that the jobless rate is moving lower again and that the weakness in the prior two months was overstated. Wage growth was warm for a second straight month. Importantly, NFP survey week is always the week that includes the 12th day of a given month. See where I’m going with that? The labor market had already rebounded by the time the FOMC met.

So, if not the labor market anymore, on what, exactly, can the Fed base its contention that the funds rate is “way above” neutral? Not on GDP, which is running 3%. Not on GDI, which was just revised sharply higher. Not on spending, which is steady. Not on core inflation, which is 120bps above target. Not on stocks, which are perched at records. Not on credit spreads, which are tight. Is it just John Williams’s model? If so, that seems like a shaky limb to go out on. Yes, it’s the most famous r-star model, but surely the incoming data matters more?

O’Rourke drove it home. “It is inconceivable that these officials should continue to guide policy by ‘feel’ when the data and the central banks’ own models indicate otherwise,” he wrote. “This is how policy mistakes are created.”