Federal Reserve Natural Interest Rate Estimate Hits 1.5 Percent

The real natural rate of interest—the inflation-adjusted level consistent with full economic capacity—is currently estimated at approximately 1.5% [1]. This benchmark serves as a critical guide for the Federal Reserve, as policy is considered accommodative when the real federal funds rate falls below this level and restrictive when it exceeds it [1].

Assessing the natural rate

The natural rate of interest is not directly observable and must be estimated, leading to significant variance depending on the time horizon used [1]. While long-run measures like the Holston, Laubach, and Williams (HLW) "r-star" provide a stable trend, they often smooth over transitory economic shocks [1]. In contrast, a new medium-run measure proposed in recent research captures both persistent economic pressures and significant short-term shifts, such as those experienced during the 2020 pandemic [1].

Data from 1987 through the fourth quarter of 2025 indicates that this medium-run measure is more responsive to business cycle troughs than traditional long-run models [1]. During the 2008 financial crisis, the medium-run natural rate fell nearly 5 percentage points, while the pandemic period saw a drop of nearly 4 percentage points [1]. By incorporating these fluctuations, the medium-run estimate aims to provide a more timely signal for policy adjustments before economic pressures fully materialize in inflation or unemployment data [1].

Policy implications and uncertainty

Despite the utility of the 1.5% estimate, uncertainty regarding the natural rate remains high [1]. Because the rate is an empirical estimate rather than a fixed observation, inaccurate readings risk leading policymakers to steer the economy too aggressively or insufficiently [1].

The Federal Reserve’s current stance is characterized as accommodative because the real federal funds rate remains below this 1.5% natural rate threshold [1]. While the medium-run measure is designed to filter out excessive volatility, it remains a model-based projection subject to the inherent challenges of forecasting economic conditions [1].

What to watch

• Future revisions: Monitor updates to the medium-run natural rate estimate, as high uncertainty bands suggest the 1.5% figure could shift with incoming data on inflation and economic growth [1].
• Policy divergence: Observe how the Federal Open Market Committee (FOMC) balances the medium-run natural rate against traditional long-run benchmarks when determining the path of the federal funds rate [1].
• Economic shocks: Watch for how the medium-run measure reacts to future transitory economic disruptions, which may signal a need for rate adjustments that longer-horizon models might overlook [1].

The reliance on a medium-run natural rate represents an attempt to improve the precision of monetary policy by using "sonar" to detect underlying demand pressures rather than reacting only to visible inflation data [1]. Whether this approach successfully stabilizes the economy depends on the accuracy of these estimates in an environment where the natural rate remains inherently volatile [1].