Fed Funds and r-star: The Natural Rate as the FOMC’s Implicit Target and the Open Debate on Its Value

r-star, the real natural rate of equilibrium, is the hidden central parameter of Fed monetary policy analysis. Its value, unobservable, determines whether the nominal Fed Funds is modestly restrictive or already neutral.

Three published estimates diverge, and the gap between the lowest and the highest remains wide in autumn 2026. This article exposes the estimates, their methods, and their implications for reading the current cycle.

r-star: Definition and Status in the Fed Reaction Function

r-star (sometimes written r*) designates the real natural rate of equilibrium, that is, the real interest rate at which monetary policy is neutral with respect to economic activity. This linkage is treated more fully in our reading of central-bank decision-making. The historical record is pieced together in our analysis of structural low-growth regimes. Neither restrictive nor accommodative. The economy operates at potential, with no upward or downward pressure on prices.

The concept is old, Knut Wicksell formalized it as early as 1898 in Geldzins und Güterpreise, but its centrality in contemporary Fed analysis dates to the 1990s, with Woodford’s formalization of central bank reaction functions in terms of the gap between observed rate and natural rate. The Taylor Rule (1993) explicitly places r-star as the additive constant in its prescription: i = r* + π + 0.5 × (π − π*) + 0.5 × output_gap. Without a retained value for r*, the rule is numerically indeterminate. On this point: the effective overnight interbank rate in the United States.

r-star therefore has a paradoxical status: it is central in the normative analysis of monetary policy (without r-star, one cannot say whether policy is restrictive, neutral, or accommodative) yet it is not directly observable. Analysts deduce it by modeling from observable variables (nominal rates, inflation, output gap, unemployment, expectations) each carrying its own measurement uncertainty. No model produces an exact point value, only distributions or central estimators with often wide confidence intervals. For more detail: the ECB-Fed rate differential.

The FOMC has never formally adopted a r-star value as an operational parameter. But the dot plot SEP (Summary of Economic Projections) published quarterly has contained since 2012 a “longer-run Federal Funds Rate” column that can be interpreted as the FOMC median for nominal neutral Fed Funds. Subtracting the inflation target (2%) yields an implicit FOMC r-star estimate. At the June 2026 SEP, the longer-run median was 3.1%, unchanged from March; the September 2026 SEP lifted it to 3.2%, the highest since March 2016, implying an r-star of about 1.2%.

This FOMC anchor is not the only reference. Several regional Federal Reserve Banks publish alternative estimates produced by their own research teams, sometimes significantly different from the dot plot. This institutional diversity informs the debate without closing it. Beyond numerical thresholds, it is the gap between observed Fed Funds and r-star + π (the nominal neutral Fed Funds) that measures the restrictive or accommodative stance. The Fed reaction function sits within central-bank assumptions, of which r-star constitutes the most contested parameter.

Competing Estimates: HLW, Lubik-Matthes, Bauer-Rudebusch, Fed Staff, Dot Plot SEP

Three estimates published as regular series dominate the institutional landscape, alongside one-off academic work. Their values diverge significantly in autumn 2026, which empirically materializes the debate’s openness.

The Holston-Laubach-Williams (HLW) estimate, published quarterly by the New York Fed, is the historical academic reference. Built by Laubach and Williams in 2003, extended by Holston in 2017, it uses a Kalman filter applied to a system of equations linking Fed Funds, output gap, inflation, and r-star. The model was re-estimated after the pandemic (“Measuring the Natural Rate of Interest after COVID-19”, Staff Report No. 1063, June 2023). In the current New York Fed vintage, which ends in the second quarter of 2026, r-star stands at 1.0% for the United States, after 0.8% to 1.3% over 2015-2020.

The Lubik-Matthes estimate, published by the Richmond Fed, uses a VAR (vector autoregression) approach with economic constraints, more direct than the HLW Kalman filter. Its philosophy is to capture r-star as a medium-term trend revealed by the history of macro variable relationships, without imposing an equilibrium structure. It is generally higher than HLW: the median Lubik-Matthes value is 1.85% for the second quarter of 2026 (Richmond Fed, updated September 23, 2026). The structural height of Lubik-Matthes partly stems from its lower sensitivity to ZIRP periods, which the model treats as transitory rather than as durable declines in r-star.

Bauer and Rudebusch (“Interest Rates under Falling Stars”, American Economic Review, 2020) infer r-star from the nominal Treasury yield curve, in a term-structure model with time-varying long-run trends. They show that ignoring the decline in r-star distorts the reading of yields and of the term premium, but their estimate is not published as a regular series: no 2026 value is drawn from it here.

The Board of Governors staff estimate is not published: public FOMC documents give no numerical range, and this article retains none.

The FOMC implicit estimate via dot plot SEP longer-run is 3.2% nominal at the September 2026 SEP (3.1% in June), that is about 1.2% real, the median of 18 participants. Individual projections cover 2.9-3.9%, that is individual r-star between about 0.9% and 1.9%. This intra-FOMC dispersion documents the absence of fully consolidated internal monetary consensus.

The gap between the lowest estimate (HLW, 1.0%) and the highest (Lubik-Matthes, 1.85%) is thus wide in autumn 2026. Applied to the 3.75-4.00% target range set on September 16, 2026, and taking the 2% inflation target as the nominal component of the long-run neutral rate, this gap yields a range of stance assessments: +75 to +100 basis points above neutral with r-star = 1.0% (modestly restrictive), down to a roughly neutral stance with r-star = 1.85%. The diagnostic depends materially on which estimate is retained.

Successive r-star Regimes Over 1960-2026

A historical reading of r-star estimates (all methods combined, weighting what is reconstructible ex post for pre-2003 periods) reveals several successive regimes over the past seven decades.

Regime 1960-1979: high and volatile r-star. The pre-Volcker period corresponds to retrospective r-star estimates ranging between 3.1% and 5.7% in the HLW model (series since 1961), with significant volatility tied to oil shocks, demographic adjustments (baby boomers entering the labor market), and high productivity growth. This range is today considered to reflect an era of capital relatively scarce against the available savings stock.

Regime 1980-2000: moderately high r-star. Under Greenspan, ex post estimates place r-star between 2.4% and 4.0% (HLW), with relative stability linked to the macroeconomic “Great Moderation”. This period allowed Greenspan to steer Fed Funds with significant legibility: policy was restrictive when Fed Funds exceeded 5-6%, accommodative below.

Regime 2000-2019: documented r-star decline. Contemporary estimates (HLW published from 2003) began signaling a secular r-star decline, attributed to several factors: demographic aging (rising savings supply from baby boomers approaching retirement), slowing productivity growth, post-2008 “safe asset shortage”, structurally lower investment rates in developed economies (Summers 2014 on “secular stagnation”). r-star stands between 0.9% and 1.3% over 2017-2019 in the current HLW vintage.

Regime 2020-2022: acute controversy. The COVID shock sent some estimates plunging (Lubik-Matthes among them), before the 2021-2022 inflationary rebound raised the opposite question while Fed Funds climbed toward its restrictive peak. This controversy triggered several methodological revisions (notably HLW, re-estimated in 2023) and an academic reassessment of the assumptions underlying the model. A parameter this central, revised several times over, says a great deal about what keeps schools of economic thought apart.

Regime 2023-2026: estimates remain widely spread. HLW stands between 0.8% and 1.2%, Lubik-Matthes consistently above it, and the SEP longer-run median implies an r-star that rose from 0.5% in 2023 to about 1.2% in September 2026. The range remains wide by historical standards, and the debate is now shifting toward the future trajectory of r-star (structural rebound toward pre-2000 levels under the effect of public deleveraging or the AI revolution, or extended stability).

Why the Debate Matters: Implications for Reading the Current Fed Funds

The practical stake of the r-star debate materializes in reading the ongoing Fed Funds cycle. Several concrete implications emerge.

First implication: the level of restrictive stance of the Fed Funds depends materially on the retained r-star estimate. With the 3.75-4.00% target range set on September 16, 2026, and taking π* = 2% as the nominal component of the long-run neutral rate, the same convention the dot plot’s longer-run column applies, the gap to r-star + π* varies significantly. With r-star = 1.0% (HLW), nominal neutral Fed Funds stands at 3.0%, a gap of +75 to +100 bp: modestly restrictive policy. With r-star of about 1.2% (implicit FOMC median, September), nominal neutral Fed Funds stands at 3.2%, a gap of +55 to +80 bp. With r-star = 1.85% (Lubik-Matthes), nominal neutral Fed Funds falls inside the target range: neutral policy.

This reading anchors on target inflation, not realized inflation, and the choice is not neutral. With core PCE at 3.4% in May 2026 (the highest since October 2023 in the vintage released by the Bureau of Economic Analysis on 25 June 2026, since revised to 3.2%), then 3.0% in August 2026 (released September 30), the nominal neutral rate computed on current inflation lands at 4.0% or more depending on r-star, at or above the top of the target range. The two conventions therefore diverge: restrictive to neutral on the long-run reference, neutral to accommodative on the current one. The distance between them measures exactly the distance between realized inflation and the target.

The diagnostic gap between the two bounding estimates thus amounts to the difference between “modestly restrictive policy” and “neutral policy”. This gap directly conditions how the cycle’s landing level is read in market analyses.

Second implication: the calibration of the Taylor Rule critically depends on r-star. As detailed in r-star in the Taylor Rule, with inflation at mandate and zero output gap, the Taylor prescription reduces to r-star + 2%. So 3.0% with the HLW r-star of 1.0%, and markedly more with the Lubik-Matthes r-star: a wide prescription amplitude on the r-star parameter alone.

Third implication: the interpretation of the dot plot SEP rests on reading the longer-run column. When the dot plot signals in September 2026 a longer-run Fed Funds at 3.2%, it implies r-star of about 1.2% (with π* = 2%). But the intra-FOMC dispersion on this parameter (2.9-3.9%, individual r-star about 0.9-1.9%) signals that internal FOMC consensus is less consolidated than the median appears to suggest.

Fourth implication: the landing level for the Fed Funds depends directly on the retained r-star level. Under a low r-star estimate (HLW), the implied landing point sits around 3.0%; under a high estimate (Lubik-Matthes), inside the current target range. That dispersion materializes the uncertainty on the terminal level, without available data allowing the debate to be settled. The June 2026 SEP moved the reference point: the median for end-2026 rose from 3.4% to 3.8%, and the 2026 core PCE projection from 2.7% to 3.3%. The September SEP, released with the 25 basis point increase, lifted the end-2026 median to 4.1% and the 2026 core PCE projection to 3.4%. For the specific unfolding of the 2024-2026 cycle and the arguments in play on its probable landing level, see r-star and the 2024-2026 terminal rate.

For the full perspective of the Fed Funds within its analytical ecosystem, where r-star is one of several structuring parameters, see the FEDFUNDS hub article of the cluster.

Last updated — 8 October 2026