Study highlights the role of productivity, global markets, and ageing demographics
As the Reserve Bank continued to ease monetary policy—cutting the official cash rate to 3.5% in its most recent move—new research sheds light on the long-term decline in New Zealand’s natural interest rate, a key benchmark that influences such decisions.
The natural interest rate in New Zealand has declined significantly over recent decades, and new research from RBNZ attributed this trend primarily to weaker labour productivity growth and a lower global natural interest rate, especially in the post-GFC era.
This decline mirrors similar shifts seen across other advanced economies. The natural rate, closely linked to the neutral interest rate, plays a critical role in guiding monetary policy, particularly when setting the official cash rate.
Modelling household behaviour and global linkages
To analyse the shift, RBNZ researchers developed a general equilibrium overlapping-generations model that considers how household saving decisions evolve over lifetimes.
The model factors in demographics, government debt levels, and global economic integration, enabling a deeper understanding of long-term capital returns.
“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 authors said.
In addition, with New Zealand’s integration into global financial markets, the research confirmed that:
“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.”
Offsetting forces: Population and participation
Although the overall trend has been downward, some factors have pushed in the opposite direction. Increased population growth and higher labour force participation among older age groups have partially cushioned the fall in the natural interest rate.
“This is because households who expect to work for longer tend to save less for retirement,” RBNZ said. “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.”
Why understanding the natural rate matters for policy
RBNZ stressed the importance of tracking shifts in the natural interest rate when designing future monetary policy. With traditional tools constrained near the lower bound, central banks must be prepared to adapt.
“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 said.
Next steps: Expanding the model’s scope
The RBNZ model provides a flexible framework for future research. It could be enhanced to capture household heterogeneity and risk premiums between safe and risky assets, providing further insights into long-run interest rate dynamics.
“The model developed in this research has a wide range of potential extensions which future work may explore,” the bank said. “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.”
