After cutting interest rates by more than 100 basis points, the Federal Reserve is contemplating how to stop, but the divisions are unprecedented

After implementing a rate cut of more than one percentage point, officials from the U.S. Federal Reserve are facing a tricky question: where is the endpoint of policy easing?

This divergence is evolving into an unusually public debate, not only concerning whether there will be another rate cut next week but also regarding the future direction of policy. Federal Reserve Chairman Jerome Powell has acknowledged that there are "strongly differing views" within the committee on how to balance the dual goals of stabilizing prices and maximizing employment.

At the heart of the debate is whether the economy needs more stimulus to support the job market or whether decision-makers should pause slightly due to inflation rates still being above target and tariffs potentially pushing prices higher. This situation makes each potential rate cut increasingly difficult and contentious.

Behind all this, a more abstract but increasingly important question is emerging: what level of interest rates neither stimulates nor suppresses the economy? This theoretical endpoint, known as the "neutral interest rate," is becoming a focal point where Federal Reserve officials struggle to reach consensus.

Views "Blooming Everywhere," Neutral Interest Rate Becomes the Focus

The "neutral interest rate" is a core concept in monetary policy theory; it cannot be directly observed and can only be inferred through models. Currently, Federal Reserve decision-makers are striving to determine its specific position.

In the latest forecasts released in September, 19 officials provided 11 different estimates of the neutral interest rate, ranging from 2.6% to 3.9%. Data shows that this is the largest divergence in officials' views on the ultimate direction of interest rates since the Fed began releasing such forecasts in 2012. Stephen Stanley, Chief U.S. Economist at Santander Bank, stated, "We see officials' views 'blooming everywhere.'"

Stanley believes that as the Fed's benchmark interest rate has reached the upper end of the aforementioned forecast range, the importance of neutral interest rate estimates is becoming increasingly prominent. He stated, "For some of the more hawkish Fed members, this is starting to become a potential binding constraint," meaning "each subsequent rate cut will become increasingly difficult."

Philadelphia Fed President Anna Paulson also expressed similar caution in a speech on November 20. She stated that the dual risks of inflation and unemployment, combined with the possibility that interest rates may be close to neutral levels, make her cautious about the December meeting. She warned, "Monetary policy must walk a tightrope," as "each rate cut brings us closer to the point where policy shifts from mildly restricting activity to starting to provide stimulus."

In addition to differing views on the current level of the neutral interest rate, officials also have disagreements about its future trajectory. It is generally believed that the neutral interest rate is driven by long-term factors such as demographic trends, technology, productivity, and debt burdens.

Minneapolis Fed President Neel Kashkari predicts that the widespread application of artificial intelligence will lead to faster productivity growth, thereby pushing up the neutral interest rate as new investment opportunities boost capital demand.

However, newly appointed Fed Governor Stephen Miran believes that short-term policies should also be taken into account. In his first policy speech after taking office, he suggested that Trump's tariffs, immigration restrictions, and tax cuts combined have (even if only temporarily) lowered the neutral interest rate, and therefore the Fed should significantly ease policy to avoid harming the economyIn contrast, John Williams, the president of the New York Federal Reserve, expressed skepticism about incorporating short-term changes into calculations, believing that global trends such as population aging are keeping the neutral interest rate valuation at historically low levels.

Market Signal Interpretations Vary, Discrepancies May Become the Norm

Since the neutral interest rate cannot be directly observed, some policymakers tend to judge its impact through market and economic indicators. Alberto Musalem, president of the St. Louis Federal Reserve, believes that lower default rates indicate that the financial environment still supports the economy. His Cleveland Fed colleague, Beth Hammack, stated that the narrow credit spreads mean that monetary policy "is only barely restrictive, even if it is tightening."

However, interpreting clues from the financial markets is not easy. Some officials view the hovering 10-year U.S. Treasury yield around 4% as evidence that financial conditions have not suppressed the economy. But others counter that these yields reflect expectations about the economic path and strong global demand for safe assets, thus having little reference value when estimating the neutral interest rate.

Analysts point out that the post-pandemic surge in prices, uncertainty in trade and immigration policies, and the unknown impact of artificial intelligence on the economy have led some to question whether differing viewpoints will become the new norm. Additionally, the Federal Reserve will experience leadership changes in 2026, with Trump having vowed to appoint a new chair focused on lowering interest rates, which could bring more decision-makers like Miran who advocate for cheap funding.

It is important to note that despite the intense theoretical debate about the neutral interest rate, it may not be a decisive factor in actual decision-making. Patrick Harker, the former president of the Philadelphia Federal Reserve who retired this year, stated that the neutral interest rate is "a useful conceptual tool, but it is just a tool and does not drive policy decisions." He added that he does not recall any meeting where the entire discussion revolved around what the neutral interest rate is.

In Harker's view, what truly drives policy decisions will be more specific factors—"labor data and price data." This provides the market with a perspective: regardless of theoretical discrepancies, what ultimately affects investors' wallets will still be the economic reports released in the coming months