There is no theory behind the “terminal interest rate”

There is much speculation about the level of the Federal Reserve’s “terminal interest rate”, i.e. the level at which the Fed Funds rate stabilises after being hiked in the exit from highly expansionary monetary policy. It has to be pointed out that there is no theory underpinning this “terminal interest rate”. It is s ometimes thought that one can write: Terminal interest rate = Neutral real interest rate + Central bank inflation target But in an open economy with free movement of capital, like the United States, the neutral real interest rate does not exist. Indeed, savings and investment do not rebalance, as an y imbalance between savings and investment is easily offset by external debt. The terminal interest rate is therefore a simple empirical choice by the Federal Reserve. Everything (the Federal Reserve’s statements, the need to keep interest rates below growth, etc.) now suggests that it will be low (1.5%) and lower than before the COVID crisis.