Analytical note

Long-run trends in New Zealand’s real neutral interest rate (AN 23/05)

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Extract from paper#

Executive summary#

Over the past few decades, there has been a persistent decline in the level of real interest rates, both in New Zealand and in many other advanced countries. This decline is thought to reflect a decline in the neutral level of the real interest rate. The neutral level of the real interest rate can be defined as the real interest rate level that would be consistent with an economy that is in equilibrium over the medium term. That is, all resources are fully utilised, inflation is stable at its target, and the output gap is closed. Whilst the neutral interest rate is not observable, and cannot be measured with much precision or certainty, it is a useful theoretical concept that can be helpful for analysing the appropriate setting of monetary and fiscal policies.

Following a long period of decline, interest rates have increased in the post-COVID-19 environment, which has raised important questions about the outlook for the structural factors affecting the level of real neutral interest rates over the long term. The objective of this note is to better understand these structural drivers. This will help us to design robust macroeconomic frameworks to ensure the effectiveness of monetary and fiscal policies in stabilising economic fluctuations.

This paper gives an overview of the literature on the drivers that have contributed to the decline in real neutral interest rates over recent decades. It considers whether the direction or magnitude of these factors are likely to change in the next few decades and possible scenarios are presented.


The author would like to acknowledge insightful feedback from Renee Philip, Bruce White (the New Zealand Treasury), and Evelyn Truong (the Reserve Bank of New Zealand).