RBNZ Research Investigates Why The ‘Natural Interest Rate’ Has Fallen In New Zealand Over Recent Decades

The fall in New Zealand’s natural interest rate has been driven mainly by declining labour productivity growth and a lower natural interest rate globally, a Reserve Bank of New Zealand Discussion Paper finds.

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. New research from the RBNZ 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.

More information

• Read the Discussion Paper

Authors: Robert Kirkby, Trent Lockyer, Andrew Coleman

• Definition of natural rate of interest: The long-run return to capital. 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).
• Definition of neutral interest rate: The nominal neutral interest rate is the level of the Official Cash Rate consistent with inflation being sustainably at target and the economy running at its potential output. When the OCR is above neutral, monetary policy restrains demand and inflation pressures. Below neutral, it is stimulatory. The level of neutral interest rates shapes expectations of where the OCR is likely to settle in the long run, in the absence of future shocks.
• RBNZ’s Additional Monetary Policy toolkit

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