NZ's neutral interest rate now below 4 percent says RBNZ
By Rebecca Howard
July 26 (BusinessDesk) - New Zealand's neutral interest rate has fallen below 4 percent and a lower New Zealand dollar
would help rebalance growth and lower the nation's net foreign liabilities, said Reserve Bank assistant governor John
McDermott in a speech.
The level of the neutral interest rate is one of three key economic trends the Reserve Bank regards as particularly
important, along with potential output growth and the equilibrium real exchange rate, said McDermott.
"These trends are the anchors around which we aim to stabilise the economy, and thereby inflation over the medium term.
While these trends are unobservable and the Reserve Bank has no control over them, they’re important to pin down so that
monetary policy can be set appropriately.”
McDermott likened them to stars the central bank uses for navigation, noting they are "unobservable and complex to
estimate."
He said the central bank's modelling points to a neutral interest rate below 4 percent, with the median of the indicator
suite currently sitting around 3.5 percent. However, "the estimates in the models from our indicator suite currently
range between 2.6 and 4.6 percent, highlighting the significant uncertainty around our estimate," he said.
"Overall a neutral rate of around 3.5 percent implies that monetary policy is stimulatory at present, given an official
cash rate of 1.75 percent," said McDermott. However, "we have been factoring in this ongoing decline in the neutral
interest rate for some time, so the overall impact on the outlook for interest rates over our projection horizon from
this particular update will be modest," he said.
According to McDermott, the neutral interest rate and the economy’s potential output are interrelated, with both factors
sharing common drivers. Potential output growth in New Zealand is currently estimated to be 2.9 percent per annum. The
current strength of potential output growth has been driven by growth in the labour supply and the capital stock. There
has been almost no contribution from productivity growth in recent years, he said. In early 2015, the RBNZ regarded the
neutral interest rate as being around 4.5 percent.
Regarding the real exchange rate, McDermott said the central bank's modelling indicates the current level of the real
exchange rate is consistent with the net foreign liabilities remaining at about 60 percent of gross domestic product. "A
lower New Zealand dollar would be needed to lower NFL-GDP and our external vulnerabilities further," he said. From a
growth point of view, a lower real exchange rate would help rebalance growth towards the tradables sector, especially as
not all traded industries are benefiting from the current high terms of trade, said McDermott.
He said another key concept is core inflation "because by filtering out temporary factors it provides a better guide to
future medium-term inflation,” he said. Core inflation is currently estimated to be 1.4 percent and has broadly tracked
sideways over the past year. "So while inflation pressures have lifted from the lows seen in early 2015, they still
appear to be relatively moderate," he added.
The New Zealand dollar was little moved on the speech and Stuart Ive, OMF private client adviser, said that given the
long and short of the speech suggested monetary policy was for the RBNZ like tracking stars that are unobservable and
complex to estimate "I suggest they get a better telescope."
(BusinessDesk)
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