In a speech at the Reykjavik Economic Conference in Iceland, Federal Reserve Governor Christopher Waller addressed the possibility of a potential increase in the key underlying interest rate, known as R-star, which influences the potency of monetary policy. Waller acknowledged that there has been a debate regarding whether R-star has seen an increase or not in the past year.

R-star is a rate that neither stimulates nor restricts the economy when inflation is at the U.S. central bank's target. Waller explained that R-star has experienced a long-term decline due to various factors, including strong demand for U.S. government debt, regulatory changes, falling inflation, and less volatile economic activity. However, there are concerns among officials about whether R-star may rise in the future, especially given demographic shifts, accelerated U.S. Treasury borrowing, and other forces at play.

If R-star were to increase, it would indicate a higher interest rate environment, suggesting that monetary policy would feature higher short-term borrowing costs compared to the historically low levels seen prior to the COVID-19 pandemic. Nevertheless, some Fed officials argue that R-star is not a key factor in near-term monetary policy considerations, citing the challenge of measuring its impact.

One of the key factors contributing to the decline of R-star, according to Waller, is the higher demand for Treasury debt issuance compared to supply. However, the situation could change due to expanding U.S. government borrowing and other factors. Waller noted that if the growth in the supply of U.S. Treasuries outpaces demand, it could lead to lower prices and higher yields, thereby exerting upward pressure on R-star. However, he emphasized that only time will reveal the extent to which the U.S. fiscal position will impact R-star.

While Waller did not comment on monetary policy or the interest rate outlook in his speech, he expressed confidence in the status of the U.S. dollar in global finance. He reassured that despite warnings about the dollar losing its preeminent status, it remains the world's reserve currency by a significant margin. Furthermore, U.S. government debt continues to be the primary form of low-risk asset, reflected in the substantial holdings of Treasury securities as foreign exchange reserves worldwide.

Nevertheless, Waller cautioned that the current trajectory of U.S. government borrowing is not sustainable indefinitely. As the global economic landscape evolves, the potential rise of R-star and the need for fiscal responsibility remain key considerations for the Federal Reserve.