The neutral rate, also known as the “natural rate,” (AKA “r-star” or r*))—is the “just right” interest rate for the economy. It’s the level that keeps growth steady and inflation stable: not so low that it overheats the economy, and not so high that it slows it down.
When the Federal Reserve sets rates below the neutral rate, it’s stimulating growth; when rates are above it, the Fed is tightening to cool things off. The neutral rate isn’t a fixed number and can change over time as the economy evolves, but most economists believe it sits somewhere around 2.5% in real (inflation-adjusted) terms.
Example:
If inflation is 2% and the Fed Funds rate is 4.5%, policy is roughly neutral—neither pushing nor pulling the economy.
