At 4.325%, the current Fed Funds rate is right at its 70-year median. This historical context, combined with large fiscal deficits, supports a contrarian view that monetary policy is actually accommodative or neutral, not restrictive as often claimed.

Fed Governor Stephen Myron argues Trump's policies will lower the neutral rate, necessitating aggressive rate cuts. Conversely, Bloomberg Economics’ model suggests these same policies—like massive government borrowing and fracturing trade alliances that reduce foreign capital inflows—will significantly increase the neutral rate, highlighting the concept's deep ambiguity in practice.

Contrary to the idea that AI justifies rate cuts, the boom is likely increasing the neutral rate of interest (R-star). By stimulating corporate investment and household consumption, AI creates upward pressure on rates, which limits the Federal Reserve's ability to ease monetary policy.

Robert Kaplan argues that with inflation at 2.75-3%, the neutral Fed funds rate is ~3.5-3.75%. Since the current rate is 3.75-4%, another cut would place policy at neutral, not accommodative. This is a risky position when inflation remains well above the 2% target, leaving no room for error.

Internal Bank of England models now indicate its policy stance might have shifted to neutral or even slightly accommodative. This internal uncertainty about the true restrictiveness of rates could limit how much further easing the UK market can price in.

Interest rates are driven by nominal GDP (real growth + inflation). A strong economy combined with persistent inflation means nominal GDP is rising, increasing the "fair value" for interest rates. If the Fed doesn't keep pace, it's effectively easing policy.

The economy's resilience to rate hikes suggests the Fed's estimate of the neutral rate (R-star) is too low. The current model is overly influenced by the "extraordinary period" after the 2008 financial crisis. The true neutral nominal rate is likely closer to 4%, meaning current policy is still accommodative.

The podcast highlights a contradiction in the argument that an AI productivity boom justifies rate cuts. Standard economic theory suggests that higher productivity increases the economy's potential, raising the equilibrium interest rate (R-star). To prevent overheating, the Fed should theoretically raise, not lower, its policy rate.

A single neutral interest rate may not exist. There could be one R-star for the investment-heavy AI sector and another for housing. A separate R-star might even be needed for financial stability. This divergence means the Fed faces a policy trade-off where a rate that balances one part of the economy could destabilize another.