Understanding key trends in the economy is crucial for the Reserve Bank, even though the trends can only be estimated and never directly observed and measured.
Assistant Governor and Head of Economics Dr John McDermott said today that three trends were particularly important: the neutral interest rate; potential output growth; and the equilibrium real exchange rate.
“These trends are the anchors around which we aim to stabilise the economy, and thereby inflation over the medium term,” Dr McDermott said in a speech. “While these trends are unobservable and the Reserve Bank has no control over them, they’re important to pin down so that monetary policy can be set appropriately.”
These unobservable factors are often denoted in economic models with a star (or asterisk). So, metaphorically, one might say it is necessary to estimate the position of the economy’s stars in order to navigate monetary policy appropriately.
“Core inflation is another important unobservable concept, because by filtering out temporary factors it provides a better guide to future medium-term inflation,” he said.
Dr McDermott’s speech provided an update on how the Reserve Bank thinks about the trends in the New Zealand economy and the changes in the trends over time. Currently, the neutral interest rate is estimated to be around 3½ percent; potential output growth is 2.9 percent; and core inflation is 1.4 percent.
The neutral interest rate has been slowly falling for some time. In part, this reflects developments in potential output growth – the sustainable growth rate of the economy. Despite a boost from strong net immigration in recent years, growth in potential output has remained much lower than in the past two expansions due to nearly no contribution from productivity growth.
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