Among the biggest questions for financial markets this year has been when the Fed would finally move away from stimulative, ultralow interest rate targets.
But what if those ultralow targets aren't actually stimulative at all? What if, instead, the Fed's current policies are actually contractionary?
That's the surprising case made by a recent paper from the San Francisco Federal Reserve.
"Monetary conditions remain relatively tight despite the near-zero federal funds rate, which in turn is keeping economic activity below potential and inflation below target," writes economist Vasco Curdia.
The insight centers around the concept of a natural rate of interest. This is the hypothetical interest rate at which money would be lent and borrowed in equilibrium, leading the economy to neither grow nor shrink. If actual interest rates are above this natural (or neutral) rate, then less money will be lent out than otherwise might be, leading economic growth to slow. Conversely, if actual interest rates are below this neutral rate, then economic expansion should result.
Seen in this context, we cannot determine whether Federal Reserve policy is expansionary simply by comparing the current federal funds rate target to historical norms. Instead, interest rate targets must be compared to that current neutral interest rate.
And according to Curdia, the neutral rate is currently below zero. Actually, he says it is currently at negative 2.1 percent, in contrast to a long-run level of 2.1 percent. If he's correct, the direct implication is that right now, even a federal funds rate target of 0 percent to 0.25 percent is high enough to slow down the economy rather than contribute to expansion.