Pushing in the other direction, high population growth and increasing labour force participation among older households have kept the natural interest rate higher than otherwise.
This natural rate of interest is closely related to the neutral rate of interest and is an important benchmark for monetary policymakers when considering the level of the Official Cash Rate.
The decline in the natural interest rate among advanced economies has been widely studied. Our new research explores the factors that have contributed to this decline in New Zealand over time.
To better understand the natural interest rate, the authors build a model capturing how households’ savings decisions change over their lifetimes. The model also accounts for the impact of changes in New Zealand demographics and government debt levels, as well as global trends.
A key driver of the decline in New Zealand’s natural interest rate is labour productivity growth, which fell in New Zealand after the Global Financial Crisis.
As captured in the model, people tend to save more as productivity growth falls, because they don’t expect incomes to rise as much in future. In turn, more savings in New Zealand flow through to a lower natural interest rate.
The natural interest rate across many advanced economies has fallen in recent decades, with the world natural rate falling about 1.5 percentage points in the post-GFC period. With New Zealand integrated into global financial markets, this lower world natural interest rate has flowed through into a lower natural interest rate in New Zealand.
The impact of these drivers has been partially offset by higher population growth and increasing labour force participation among older households. This is because households who expect to work for longer tend to save less for retirement. Higher population growth means more younger households in the population, who tend to save less than older households. Lower domestic savings means a higher natural rate of interest.
Understanding the drivers of changes in the natural interest rate is important for central banks and helps inform expectations on where the natural rate will move in future.
“If the natural and neutral rates of interest remain low, this would suggest an ongoing need for alternative monetary policy tools when encountering the effective lower bound (close to zero interest rates) on central bank policy rates,” the authors say.
The model developed in this research has a wide range of potential extensions which future work may explore. These extensions could include modelling different types of households in more detail or introducing a risk premium between the return to safe and risky assets.
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Non-technical summary of the discussion paper
In this discussion paper, we study the natural rate of interest, or the long-run return to capital, in New Zealand. The level of the natural rate of interest reflects the underlying balance between the amount of savings (from households or overseas investors) and demand for capital (from businesses and the government). This concept is closely related to the neutral rate of interest and represents an important benchmark for monetary policymakers.
Most evidence suggests the natural rate of interest has declined over recent decades – both in New Zealand and overseas. This discussion paper develops a general equilibrium overlapping-generations model to study the drivers of this decline. The model is designed to capture the features of a small open economy like New Zealand, and this allows us to consider the influence of both global and domestic trends between 2000 and 2024.
We find that declining labour productivity growth, and a lower world natural rate of interest have been the most important factors contributing to the fall in New Zealand’s natural rate of interest since 2000. The impact of these drivers has been partially offset by higher population growth and increasing labour force participation among old-age households. We find that changes in government debt and increasing longevity have not had major effects.
Why did we do this research?
The decline in the natural rate of interest across many advanced economies in recent decades has been widely studied in modern macroeconomics.
Understanding the drivers of this decline is an important topic for central banks, to help inform expectations on where the natural rate will move in the future. Whether the drivers of this decline can be expected to unwind, or whether the natural rate is likely to remain low relative to historical levels has several implications for monetary policy. If the natural and neutral rates of interest remain low, this would suggest an ongoing need for alternative monetary policy tools when encountering the effective lower bound on central bank policy rates.
What data did we use?
We considered 6 drivers of the natural rate of interest in New Zealand.
| Driver | Measured by | Source |
|---|---|---|
| World natural rate of interest | Estimates of the United States natural rate of interest | Holston et al. (2017) |
| Population growth | Estimates of the New Zealand population by age cohort |
Statistics New Zealand |
| Labour productivity growth | Gross Domestic Product (GDP) per-capita | Statistics New Zealand |
| Government debt levels |
The gross government debt-to-GDP ratio | New Zealand Treasury |
| Old-age labour force participation | Labour force participation rates among age cohorts older than 65 | Statistics New Zealand |
| Longevity | Age-specific death rates, and estimates of the population estimates by age cohort | Statistics New Zealand |
A range of other macroeconomic data was used to calibrate the model parameters to match key aspects of:
- how New Zealand households make savings and bequest decisions over their lifetimes
- the income distribution in New Zealand
- New Zealand’s tax and transfer system (the pension scheme)
- the demographic profile of the New Zealand population.