Luci Ellis: The neutral rate - the pole-star casts faint light

Keynote address by Ms Luci Ellis, Assistant Governor (Economic) of the Reserve Bank of Australia, to the Citi Australia & New Zealand Investment Conference, Sydney, 12 October 2022. 

The views expressed in this speech are those of the speaker and not the view of the BIS.

Thanks to Citi for the opportunity to speak today. My topic is the so-called 'neutral interest rate'. The concept has attracted a lot of attention in recent months. It's no surprise why. Until earlier this year, policy interest rates – in Australia, the cash rate target – had been held at very low levels to support economies through the COVID-19 pandemic and into recovery. Such low levels are understood to be unusual – they are an emergency setting for extraordinary times.

But now, with unemployment close to a 50-year low and inflation currently very high, policy stimulus is no longer needed. It's natural in these circumstances to think of policy getting back to a 'more normal' setting – although one could argue that times are still far from normal, just in a different way to the previous two years. Regardless, it's understandable that in recent months people have been wondering what 'normal' policy might be. To the extent it means 'no longer providing stimulus', this then becomes a question of what 'neutral' policy might mean. Economic theory contemplates a risk-free or policy rate that can be considered 'neutral'. This rate – whatever it is – is usually labelled 'r *'.