The RBNZ's view on the neutral interest rate highlights a risk it thinks current monetary policy settings 'are more stimulatory than they actually are'

The RBNZ's view on the neutral interest rate highlights a risk it thinks current monetary policy settings 'are more stimulatory than they actually are'

The neutral interest rate, the dividing line between where interest rates are stimulating or constraining economic activity, remains 4.5%, according to the Reserve Bank.

This is the conclusion drawn in a Reserve Bank Analytical Note entitled Estimating New Zealand's neutral interest rate, by Adam Richardson and Rebecca Williams.

It's something of a surprise that the Reserve Bank has retained this view, which the central bank has had since October 2013, given both Governor Graeme Wheeler and Assistant Governor John McDermott have recently hinted the Reserve Bank may lower its view of what the neutral interest rate is.

"Estimates suggest the nominal neutral 90-day interest rate sits between 3.8 and 4.9 percent currently," Richardson and Williams say. "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," Richardson and Williams added. "The Bank will continue to monitor the validity of these assumptions when considering policy settings."

They go on to say interest rates that are most important for influencing behaviour are the ones actually faced by businesses and households.

"In this regard, the floating mortgage rate is an important benchmark rate that the Bank monitors when it sets policy. The nominal neutral floating mortgage rate is currently assumed to be 7 percent, having been lowered by 100 basis points over 2008 and 2009."

'A neutral 90-day bank bill rate is currently under 3.5%'

ASB senior economist Chris Tennent-Brown said the Reserve Bank could've lowered its view, and not doing so highlights a risk the Reserve Bank thinks current monetary policy settings are more stimulatory than they actually are.

"In essentially sticking with the 4.5% neural view, the implication is the Reserve Bank views the current 90-day rate of 2.84% as very stimulatory, and were stimulatory before the Bank commenced its easing cycle in June this year.  In contrast we think that a neutral 90-day bank bill rate is currently under 3.5%, implying that interest rate settings were neutral, possibly even slightly restrictive, before the 2015 easing cycle began, and have only just moved into stimulatory territory over recent months," Tennent-Brown said.

"In saying that, the Reserve Bank does acknowledge that the models highlight an 'emerging risk that the neutral interest rate is falling further'. Today’s paper doesn’t change our view that the Reserve Bank needs to cut the OCR further (from 2.75%). In our view though, the paper highlights a risk that the Reserve Bank thinks current policy settings are more stimulatory than they actually are," said Tennent-Brown.

'A true read requires the removal of the LVR restrictions'

The Reserve Bank's view did, however, get more sympathy from BNZ senior economist Craig Ebert.

"Anyone excited that the Bank might drop its estimate of what a neutral short-term NZ interest rate is these days would have been sorely disappointed. Yes, the paper, in running through a range of neutrality methods and measures, did infer a declining path since before GFC (Global Financial Crisis). However, still only a very mild downward trend. And so not quite to the point of tipping the bank’s neutral OCR estimate to 4.00%," Ebert said.

BNZ's economists agree with the Reserve Bank's line of thinking, Ebert added.

"We believe too many people have been too quick to over-extend the tendency toward a 'new-normal' on interest rates. Yes, the new equilibria are probably materially lower than they were 10 to 20 years ago, for a range of entirely valid reasons. However, there is a limit. And it’s far from zero. For those pointing to the lack of credit growth as a counter-example we would point out that 1) New Zealand’s is, in fact, picking up and 2) to get a true read on the force of current interest rate settings one would need to remove the Reserve Bank’s LVR (loan-to-value ratio) restraint. Then we could easily imagine household credit growth well in excess of 10% per annum," said Ebert.

Although the Analytical Note says the views expressed are those of the authors and don't necessarily represent the Reserve Bank's views, at this month's Monetary Policy Statement press conference Wheeler said this note was coming, and it would, "give all the details about how we measure neutral, (and) what our best view is at the moment."

Richardson is an adviser in the Reserve Bank's policy analysis team, and Williams is a senior analyst in the issues team. 

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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Today’s paper doesn’t change our view that the Reserve Bank needs to cut the OCR further (from 2.75%).

To achieve what exactly, beyond that which ZIRP has failed to deliver in other jurisdictions?

(1) Lower mortgage interest rates. (2) Achieve the RBNZ's policy target of maintaining 1-3% inflation (which it is failing miserably at doing so far due to its unhealthy and politically motivated focus on the Auckland property market). (3) ZIRP in other jurisdictions is not relevant to NZ's situation. (4) It is wrong to point to a ZIRP in other jurisdictions not increasing inflation to a target level; the real question is what would happen without a ZIRP in those countries. (5) Lower dollar which is helpful in a slowing economy.

Over indebted by any chance?

No, lower interest rates mean less money to the bank and more for me (and the tax man); what's not to like about that...

Term deposits by any chance?

Read my next comment down.

I don't think you'll be able to beat the 20% annual return on my Auckland renters. But if the doomsayers are right that gain will be gone when Auckland property prices fall by 2/3rds next month...

I don't think you'll be able to beat the 20% annual return on my Auckland renters.

Do you think those paying the rent were in receipt of a income jump any where close to that return?

Which brings me back to my original question.

It doesn't concern me. Supply and demand. If my tenants want out there is a line 50 deep waiting to step up.

And back to your original post, the more money I get to keep due to lower mortgage rates (i.e. rent I receive and I do not need to pay to the bank) I will spend in the economy thereby helping to meet the RBNZ inflation target.

Am I missing something?

Yes, you are not the majority.

We're way off topic now. The basic premise is a lower OCR is more likely to cause an increase in the CPI. Unless you are saying that premise is wrong what are we talking about?

Simply your spending of that extra income on discretionary items ( cars or overseas trips for example) would not be as efficient as your tenant spending on essentials.
Your thinking is typical of the already advantaged.

You are assuming I live the life of Riley. The items I purchase will be just as likely to be in the basket of goods and services my tenants would buy and will impact on the CPI. Furthermore, why is me paying less interest mean there is less disposable income for my tenants? You sound jealous.

I suspect that the truth would reveal and absence of it.

Typical landlord, your theft like receipt of unearned rentier income is apparently a free lunch to you. Did you ever stop to think that maybe there are limits to your extraction of the wealth of others, and perhaps consequences to you for the theft?

Free lunch? You reek of envy. While you are sitting around this weekend drinking beer and watching the rugby world cup I will be maintaining my properties. Waterblasting, painting, repairing decks. Stop crying and pull finger.

..well if you got out of the market you would give some of those younger people who can't get tax deductions on their interest rates and insurance etc a half chance of making a home for themselves. I'm not young, not a rentier, but I detest what this govt lets you lot suck off the next generation.

Do you expect me to envy criminals? Your typical low calibre fallacious response reinforces the stereotype you just fulfilled for a rentier aristocrat wannabe. Did you even bother to google the term unearned income and form some understanding of what you do?

Scarfie... u are sounding like a Zealot... there is nothing criminal or wrong in what HeavyG does..
He is simply being smart and working in his own self interest... ie.. preserving his own wealth.

If there is any criminality, or corruption ...it is in the "system" itself... The system that allows extreme amounts of credit growth... Basically the debasement of fiat money..
In my view, in aggregate, putting aside supply/demand forces ... most Property price gains are simply the result of the lose of purchasing power of money...as a result of money supply growth.
In NZ M3 money ...over the last 30 yrs has grown at a compounded rate of 6% /yr...
Total House Values in NZ has also grown at compounded rate of about 6% over the last 30 yrs...
The corruption is in our Monetary system..and any criminality lies at the feet of those running it.... I suppose.
Nothing wrong with , as an individual, being smart enuf to see all that and make the decisions to preserve ones own wealth.... don't u think..??
In todays world of financial repression.... it is easy to see why people see Real Estate as a good way to preserve wealth.... ????

So someone is a criminal because you say so. Stop living in the google world and get into the real one. Try reading the "ant and the grasshopper". Life 101 is about choices. Some of my tenants left school at 16 and had six kids. I went to university and had my first child in my 30s after amassing a rental portfolio. I don't begrudge them their choice to have lots of kids at a young age. Why the hostility against my choice to delay my family until I had financial security.

I know what "unearned income" (I prefer the term "passive income" which is more accurate) is, I just do not support your Marxist perjorative use of the term. If anyone sounds like a criminal here it is you, what are you proposing?... Stealing my property for the greater good (i.e. those who made different life choices)?

Heavy -how exactly does it mean less money for banks ? I think you're confusing savers and investors with banks. Yes it means less money for investors and retirees and older mums and dads, pensioners, and more importantly globally, pension funds, many of which have defined benefit schemes and which is forcing them into investing into over inflated assets to try to get the 7-8% returns they need to met their commitments and survive - a big part of the next crisis generated by central banks bailing out over extended borrowers with low interest rates, which will only last until the asset bubble bursts and then it will be a case of bailing out the investors

Less of "my" money going to the bank. But in respect of the impact on inflation I think the premise still stands a lower OCR is more likely to result in a higher CPI (comparative to a higher OCR). I am not hearing any analysis to counter this proposition.

Play spot the BB'er "higher interest rates needed"

BBer's who are not making a killing from lower rates are indifferent to their wealth prospects or are perpetual workaholics. Read more

To suggest there is a fixed neutral interest rate in NZ without reference to interest rates elsewhere seems way too simplistic, and potentially a cause of significant policy errors.
When US interest rates are 0.25%, then ours at 2.75 are borderline restrictive, given the exchange rate effects.
If the US was back at say 4%, then our 2.75% would likely be stimulatory, through having an exchange rate lower than fair value. Mr Wheeler seemed to ignore this relationship last year when he put rates up, while bemoaning that the exchange rate was way too high, as though the two things were not linked in any way. He seems to have learned his lesson.

Can you point the readers to corroborating research?

The RBNZ started their tightening cycle in March 2014, although Mr Wheeler even then said the exchange rate was unjustifiably and unsustainably high. The NZD USD cross rate was ~85c. This rate peaked around mid July at 88cents, despite Wheeler trying to talk it down. The tightening cycle ended in July 2014. That timing does not seem a coincidence. The cross rate drifted down with dairy prices to 76c in April this year when Wheeler made it clear that the next move was likely to be down. The cross rate has declined dramatically since then through the easing cycle to its current 63-64c.
A look at a graph of these effects shows very clear changes in direction perfectly aligned with the changes in direction indicated by Wheeler.

Can you rationalise the relationship when Bollard dropped the OCR by 100 bps in response to the ChCh earthquakes - where Auckland spivs got most of the benefit but Cantabrians did the suffering

For me... The neutral rate is the measure of how"punch drunk" an economy is... ( in my view)...
otherwise its' kinda meaningless... just an intellectual , academic fancy... which just tries to quantify the obvious.. ie. indebted economies need lower and lower interest rates to simulte credit growth, and economic activity...after each recession... ( this is a game that has an end )

Not a good sign that our economy could not even get to the neutral rate ..before sinking towards lower growth. ????

the neutral rate has nothing to do with what Hayek called the natural Rate of interest .. ( which is an information transmitting mechanism).. ( The natural rate balances savers vs borrowers.... balances consumption vs investment ) ( The Natural rate does not exist, in what is a Central Bank , contrived interest rate and unfettered credit growth World )

The model for "Creditism".... is that each recession requires lower % rates to have the same stimulative effect.... in regards to credit growth leading to GDP growth.

The Game ends when there are no credit worthy Borrowers left .... and no one wants to borrow at any rate... and existing borrowers can't honour their debts... Neutral rate doesn't exist then..

For me ...the neutral rate is just of an academic interest...kinda meaningless.. whereas I would view Hayeks' "Natural Rate"... to be very important in having a balanced economy... but that would require a ,kinda, relatively stable money supply / Monetary system....

What about the Wicksellian natural rate version of events?

Over a century ago Knut Wicksell, a Swedish economist, drew the distinction between the financial rate of interest that borrowers actually pay and the natural rate of interest that was determined by the return on capital. If the financial rate is below the natural rate, businesses can reap unlimited profits by borrowing as much as they can and ploughing it into high-returning projects. Eventually, though, all that additional spending pushes up prices, money and credit, and eventually, financial interest rates. Read more