The Reserve Bank of New Zealand has today published a paper in its Analytical Notes series on Estimating New Zealand’s neutral interest rate. In the paper they run through a number of different methods to derive this indicator rate, and observe the mean is 4.3%. Strikingly this mean rate has been falling for a number of years, and is a further indicator of lower rates around the world.
It is important for the Reserve Bank of New Zealand to understand the extent to which current monetary policy settings are either contractionary or expansionary with respect to the macroeconomy. As a benchmark for this analysis, the Bank estimates a level of the nominal 90-day bank bill rate that it believes is neither expansionary nor contractionary. This benchmark interest rate is termed the ‘neutral interest rate’.
The neutral interest rate is unobservable and significant judgement is required to assess its current level. The Bank continually monitors the economy for possible changes in the neutral interest rate. This includes a broad assessment of consumer attitudes towards debt and risk, the economy’s potential growth rate, and international developments. Signs that the neutral rate may be changing are initially incorporated into the Bank’s risk assessment when setting policy. If the economy shows clear signs of a change in the neutral interest rate, the Bank will formally change its estimate in its various modelling frameworks.
The Bank looks at a range of model-, survey-, and market-based estimates of the neutral rate to help inform this ongoing judgement. This paper outlines the methodology the Bank uses to arrive at these model-, survey-, and market-based estimates. The Bank currently uses five key methods to help inform judgements about the neutral interest rate. These include:
• a neo-classical growth model;
• implied market expectations of long-horizon interest rates;
• analysts’ expectations of long-horizon interest rates;
• analysts’ expectations of long-horizon annual nominal economic growth; and,
• a small New Keynesian model.These estimates suggest the nominal neutral 90-day interest rate sits between 3.8 and 4.9 percent currently. The mean of these indicators is 4.3 percent.
The Bank currently judges that the nominal neutral 90-day interest rate sits at 4.5 percent – within the range of estimates and close to the mean of these estimates. This implies that current monetary policy settings are expansionary, although these models highlight some emerging risk that the neutral interest rate is falling further. The Bank will continue to use these five methods, along with broader monitoring of the economy, to help identify any possible changes in the neutral interest rate. Furthermore, the Bank will continue to look for ways to improve its estimates, including the development of other estimation methodologies.
