Successful central banking requires balance. Monetary policies that are too tight can lead to recessions and high unemployment; those that are too loose can help trigger high inflation. By law, the US Federal Reserve (Fed) is required to pursue monetary policies that support stable prices and maximum employment; that is, they are required to fulfill two objectives that can appear to be, in certain circumstances, contradictory. Hence, balance.
So, how can the Fed find the proper equilibrium to manage its dual mandates? Part of the answer is to find the interest rate that perfectly balances jobs and inflation. The trouble is, no one knows for sure what that interest rate is. Modern economies are dynamic and complex. Actions taken today might have influences on product and financial markets that can take months to occur. The right rate today might be the wrong rate next month, especially when economic conditions are changing rapidly. Identifying the right rate, which economists call R* (pronounced R star) is hard, but to paraphrase Joni Mitchel, it’s the work the Fed has taken on, finding the R* maker machinery behind the economy. In the past few months, however, R* has come under attack as a policy tool.