Why NZ's neutral interest rates have fallen

Release date
02 October 2013

New Zealand's ‘neutral' interest rate appears to have fallen, and this will have a bearing on the interest rates households and businesses will face over time, Reserve Bank Assistant Governor John McDermott said today.

The neutral interest rate is the rate that neither stimulates nor restricts the economy when it is growing with no under- or over-utilised resources in aggregate (often referred to as a zero output gap), and inflation is close to the midpoint of the 1 to 3 percent target band.

Speaking to the New Zealand Institute of Chartered Accountants CFO and Financial Controllers Special Interest Group in Auckland, Dr McDermott noted that factors that can affect the neutral interest rate include world conditions, domestic productivity growth, population growth, and preferences for savings and investment. The drop in the Reserve Bank's estimates of New Zealand's neutral interest rates is largely due to weaker productivity growth in recent years.

He noted that the Bank's latest forecasts project the output gap to be near zero and inflation to be close to the 2 percent midpoint in March 2016. Consequently, the appropriate monetary policy setting at that time should be very close to neutral.

The Bank's projections suggest the level of the nominal 90-day interest rate that achieves this is about 4½ percent, with a confidence band of perhaps ½ percentage point each side of the central estimate.

"Lower neutral interest rates imply that the interest rates faced by household and businesses over the longer haul are likely to be lower than in the past. But interest rates will still need to be adjusted in response to the state of the economy," Dr McDermott said.

Dr McDermott said that the Reserve Bank over recent years lowered its assumption of neutral 90-day rates within its forecasting framework in line with its lower estimates of the neutral rate.

View the speech: Shifting gear: why have neutral interest rates fallen?

Angus Barclay
External Communications Adviser
Ph 04 471 3698, angus.barclay@rbnz.govt.nz