NZ neutral rate fell after 2008, now rising again
The Reserve Bank has released new research estimating New Zealand’s neutral interest rate using a Vector Error Correction Model (VECM).
The study, authored by Willy Alanya-Beltran, finds that the neutral rate – where monetary policy is neither expansionary nor contractionary – must be estimated rather than directly observed.
The VECM approach draws on the long-term relationship between short- and long-term real interest rates to track shifts in the neutral rate over time.
A recent RBNZ bulletin said the neutral OCR is about 3.9%. The bulletin noted, “While our indicator suite suggests a long-term NIR of around 2.5%, interest rates currently need to be substantially higher in the short- to medium-term to exert downwards pressure on economic activity.”
Key findings: Trends and policy implications
The analysis reveals that New Zealand’s real neutral rate has shown a downward trend since 2008, starting from around 4%, dropping to negative values during the onset of the pandemic in 2020, and then steadily rising back to positive territory by the end of 2023.
According to the note, “Long-term estimates of the nominal neutral rate under this framework suggests that monetary policy was contractionary from 2022Q2 to 2023Q4.”
Understanding the drivers of change
One of the strengths of the VECM approach is its ability to decompose the drivers behind changes in the neutral rate.
“Interest rates dynamics explain most of the change in neutral rates between 1997 and 2023,” Alanya-Beltran said. “However, I also find the following factors contribute to the decline in neutral rates: lower productivity, appreciating nominal exchange rates, and to a lesser degree, a decrease in real investment and higher public debt.”
RBNZ noted the complexity and uncertainty in estimating the NIR, stating, “we cannot rely on any single estimate of the NIR for New Zealand.” Setting the OCR above the neutral rate is a key tool for controlling inflation and maintaining stability.
Why the research matters
This research introduces a novel multivariate regression approach for New Zealand, not currently included in the Reserve Bank’s range of neutral rate models.
“The estimated neutral rate under this framework can be decomposed to assess the contribution of each data series to the change in neutral rate over the estimation period,” the note said.
The VECM method “better captures interdependencies between the economic variables compared to structural models, allowing for data-driven relationships and considering a larger number of variables to decompose the movements in the neutral rate.”
The findings show that the VECM r* is broadly consistent with existing RBNZ neutral model estimates, highlighting its value as a complementary tool for policymaking and economic analysis.
Why this matters for mortgage advisers
Understanding the neutral interest rate helps mortgage advisers explain why mortgage rates are currently high and may remain elevated. With the OCR set above the neutral rate to control inflation, advisers can use this context to guide clients on rate trends, refinancing, and timing their borrowing decisions. Staying informed about these economic drivers adds value to client conversations and planning.
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