Reserve Bank of New Zealand discussion paper finds weaker productivity growth and lower global rates drove New Zealand’s natural interest rate down since 2000

The Reserve Bank of New Zealand published research assessing why New Zealand’s natural rate of interest has fallen over recent decades, a benchmark closely related to the neutral rate used by policymakers when considering the level of the Official Cash Rate. Using a lifecycle savings model tailored to a small open economy, the paper concludes that the main drivers of the decline since 2000 have been weaker labour productivity growth and a lower world natural rate of interest. The model links the productivity slowdown after the Global Financial Crisis to higher household saving as expected future income growth falls, which lowers the natural rate. It also finds that a lower world natural rate, estimated to have fallen by around 1.5 percentage points in the post-GFC period, has flowed through to New Zealand via global financial integration. These effects are partly offset by higher population growth and rising labour force participation among households older than 65, which the model associates with lower retirement saving and a larger share of younger, typically lower-saving households, pushing the natural rate higher. Changes in government debt and increasing longevity are not found to have had major effects. The authors note that if natural and neutral rates remain low, central banks may face an ongoing need for alternative monetary policy tools when policy rates approach the effective lower bound. Future work could extend the framework by modelling household types in more detail or adding a risk premium between safe and risky returns.