US Federal Reserve (Fed) governor Christopher Waller said he still thinks the neutral interest rate is relatively low, though he warned that unsustainable fiscal spending could alter that trend.

“In the near term, I don’t see anything that has really caused me to change my view that the r-star is relatively low,” Waller said on Friday on the sidelines of the Reykjavik Economic Conference in Iceland. “It could change in the future, but that’s what we need to keep an eye on.”

Waller’s comments to Bloomberg News followed a speech he gave at the conference on the neutral rate, which economists often refer to as the 'r-star'. He didn’t offer any views on the near-term outlook for monetary policy in his speech, instead focusing on longer-term trends that have pushed the rate lower over time and prospects of a reversal.

“The US is on an unsustainable fiscal path,” Waller said in his prepared remarks. “If growth in the supply of US Treasuries begins to outstrip demand, this will mean lower prices and higher yields, which will put upward pressure” on the neutral rate, he said.

US central bankers have pointed to the longer-run neutral rate, which economists refer to as the r-star, as a central topic for policy discussion this year.

The neutral rate is a theoretical concept that describes a policy setting that neither stimulates growth nor slows demand. It can’t be observed in real time, and estimates have a wide range of uncertainty around them. Fed officials’ latest estimates published in March ranged from 2.4% to 3.8%.

“One vital fact about the r-star is that it is a theoretical concept, without any reliable and straightforward way to determine its value,” Waller said.

Nevertheless, policymakers are wondering whether the rate has moved up, because the economy seems to be responding less to higher rates than they would have thought. Their median estimate for the rate in March was 0.6% after adjusting for inflation. With rates in a range of 5.25% to 5.5% now, and year-ahead inflation priced at a little higher than 2% in swaps markets, policy should be sharply restrictive, but the economy continues to grow at a solid pace.

Waller focused on the US 10-year Treasury yield as a proxy for the r-star, and listed several trends that may have pushed it down:

• Lower inflation and economic volatility made holding longer-run Treasuries more attractive
• The liberalisation of capital markets worldwide helped create more demand for safe, liquid assets such as Treasuries, pushing yields down
• Holdings of dollar assets by official foreign institutions such as central banks and sovereign wealth funds rose
• Domestic demand for Treasuries increased as retirees need more safe, liquid assets, regulations require banks to hold more liquid securities, and the central bank has increased its own holdings

“I do not believe any of these factors can explain the possible recent increase in the r-star, but some may conceivably be a contributing factor to an increase in the future,” Waller said.

  - Bloomberg