The Neutral Rate Is A “Guide” Not A “Destination”

RBA Deputy Governor (Economic) Ellis noted today in a speech on the neutral rate that it is probably at least 2.5%. She emphasised that it is only a guide and not a goal in itself. Her comments were consistent with Governor Lowe’s previously.

• She explained how the RBA estimates where neutral is. The results of the 9 models are averaged. These models cover three approaches:
  • 1.The neutral rate is inferred from financial market pricing
  • 2. Real policy rate if inflation is at target, output at potential and the economy at full employment
  • 3. Estimate of the future value of the policy rate once all cyclical influences have dissipated
• The average estimate of the real neutral policy rate from these models is just under 1% but Ellis stated that there is considerable uncertainty around this figure.
• Currently, nominal policy rates are below the average estimate of neutral (about 3%) and also below the range of estimates (about 3-4.5%). Graph 6 in her speech shows the average nominal neutral rate and the range of estimates. But neutral is only a guide and the RBA makes a “holistic assessment of the forces that are affecting the economy”.
• Both the nominal and real neutral rates have been trending down over time until recently.
• “The neutral rate is an important guide rail for thinking about the effect policy might be having. It is not necessarily a prescription for what policy should do.” (Ellis)
• See "The Neutral Rate: The Pole-star Casts Faint Light" here.