Powered by MOMENTUM MEDIA
investor daily logo

Neutral rate ‘not a prescription of what policy should do’, says RBA official

  •  
  •  
4 minute read

Australia’s neutral interest rate is at least 2.5 per cent, a senior RBA official has said.

Reserve Bank (RBA) assistant governor Luci Ellis said Australia’s neutral interest rate is probably at least 2.5 per cent, but explained that it serves as a mere guiding star and not a determinant of the bank's policy. 

“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,” Ms Ellis said at a Citi conference on Wednesday.

“‘Neutral’, then, is not a destination we necessarily reach, but more a pole star to guide us,” she noted.

==
==

A neutral rate describes an interest rate at which monetary policy is neither stimulating nor restricting growth. The RBA has raised interest rates by a cumulative 2.5 per cent since May, marking its fastest pace of tightening in a generation.

Although the current rate which stands at 2.6 per cent is close to the bank’s neutral estimate, Ms Ellis explained that in an inflationary environment, the bank needs to be “mindful of the limitations of our instruments, and of the prospect that the stars themselves can realign”.

“Its location [neutral rate] is sufficiently uncertain that we are perhaps better served by paying more attention to the ground as it shifts beneath our feet than to that faraway pole star,” she said.

“But as we navigate the narrow path to our intended goal, we welcome any faint light that those stars may cast,” she added.

Ms Ellis also explained the intricate procedures the RBA uses to measure the neutral rate, which includes nine different models to estimate it.

She also touched on the consequences of a low neutral rate, explaining that while it is not necessarily good or bad for the neutral rate to be at a particular level, “a low neutral rate in a low-inflation world means that the economy could be more frequently constrained by the effective lower bound”.

“It becomes harder to stimulate the economy when needed. The central bank must resort to other measures beyond reducing the cash rate to support the economy. This is one reason why central banks have inflation targets that are above zero,” Ms Ellis said.

Another implication, she explained, is that it can make it harder to achieve a desired rate of return.

“So, investors with a mandate to achieve an absolute return could end up taking on risk that they would otherwise not take.”

Ms Ellis also warned that the neutral rate could increase at some points.

“This is also plausible,” she said, particularly when the factors holding back productivity growth dissipate.

“Those who look forward to a future of faster productivity growth must recognise that this will likely imply higher real rates as well as higher trend growth,” she noted.

“This matter's for investors, borrowers and fiscal authorities alike. These implications are mostly benign, but not if global productivity growth picks up and Australia does not keep pace.”

Neutral rate ‘not a prescription of what policy should do’, says RBA official

Australia’s neutral interest rate is at least 2.5 per cent, a senior RBA official has said.

investordaily image
investordaily image
ID logo
Maja Garaca Djurdjevic

Maja Garaca Djurdjevic

Maja's career in journalism spans well over a decade across finance, business and politics. Now an experienced editor and reporter across all elements of the financial services sector, prior to joining Momentum Media, Maja reported for several established news outlets in Southeast Europe, scrutinising key processes in post-conflict societies.

Comments powered by CComment