Neutral Interest Rate
AdvancedThe neutral interest rate is the theoretical interest rate at which monetary policy is neither stimulating nor restraining the economy, consistent with full employment and stable inflation.
When a central bank sets its policy rate above the neutral rate, policy is restrictive, slowing growth and reducing inflation. When it sets the rate below neutral, policy is accommodative, supporting growth.
The neutral rate is often expressed in real terms, after inflation, and is sometimes called r-star or the natural rate of interest. Adding expected inflation gives a nominal neutral rate. For example, if the real neutral rate is estimated at 1% and inflation is expected to be 2%, the nominal neutral rate would be about 3%.
The neutral rate cannot be observed directly. Economists estimate it using models, and estimates vary widely and change over time. It is influenced by long-term factors such as productivity growth, demographics, saving and investment patterns and global demand for safe assets.
Many economists believe the neutral rate fell in advanced economies over several decades before 2020. Whether it has since risen is debated. Uncertainty about the neutral rate makes it hard for central banks to know exactly how restrictive their policy is.
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