One big question being debated right now is whether the "natural'' real rate of interest -- r* or "r-star" in econspeak -- has declined below 2%.
Over the long run, the Fed cannot control the real rate of interest -- that comes from how much people want to save and what opportunities there are for investment, i.e. the marginal product of capital. So, if the real rate of interest is now permanently lower, say 1%, then one might argue that the glide path should aim for 3% long-run interest rate -- 1% real plus 2% inflation target -- not 4%.
Janet Yellen recently came to Stanford and gave a very interesting speech that talked in part about a lower r-star, and seemed to be heading to something like this view. See the picture:
|Source: Federal Reserve.|
(She also talked a lot about Taylor Rules, seeming to move much closer to John Taylor's view of how to implement monetary policy. See interesting coverage on John Taylor's blog. On r*, see Measuring the Natural Rate of Interest Redux by Thomas Laubach and John C. Williams for a central paper on r*. Henrike Michaelis and Volker Wieland have an interesting post on r* and Taylor rules, also commenting on Ms. Yellen's speech.)
Of course, cynics will say that it's just the latest excuse not to raise rates. But these are serious arguments which should be considered on their merits.
Should the glidepath head to 3% interest rates? Maybe not. How about zero?