29 January 2025 – In a speech delivered today, Reserve Bank Chief Economist Paul Conway discussed New Zealand’s longer-term ‘potential output’ and its significance for monetary policy.
“Understanding potential output is crucial for assessing whether the economy is running too hot or too cold from an inflation control perspective and for gauging medium-term growth prospects,” Mr Conway says.
Mr Conway also outlined the Reserve Bank’s assessment of the ‘neutral interest rate’, which shapes expectations for where the OCR will tend to move over time, in the absence of economic shocks.
The speech goes beyond the business cycle to explore New Zealand’s long-term economic challenges and key factors influencing future growth – including productivity growth. It also explores drivers behind changes in New Zealand’s neutral interest rate.
Key insights from the speech include:
- In the absence of future shocks, economic activity in New Zealand will tend towards the level of potential output, as pandemic-related disruptions fade. Likewise, without future shocks, the OCR will tend towards the neutral interest rate.
- Over the next few years, with declining inward migration and weak productivity growth, potential output growth is likely to be modest. This will set a modest ‘speed limit’ on how fast the economy can grow without generating excess inflation pressure.
- Unlocking higher investment and productivity growth is key to raising potential output growth and improving per capita incomes. This would also reduce the likelihood of negative recessionary economic growth during future periods of restrictive monetary policy.
- Reserve Bank estimates suggest that the neutral interest rate has fallen over recent decades, given weak productivity growth and aging populations. Our research suggests that this decline may be reversing and that the long-term nominal neutral interest rate currently lies between 2.5% and 3.5%.
Background notes
What is potential output?
Potential output is the level of goods and services the economy can sustainably supply without generating excess inflation or disinflation. It depends on the supply of inputs – capital and labour – and how productively they are combined to produce output. For example, if there are more people available to work, more capital to use, or better ways of doing things, then potential output increases.
What is the neutral interest rate?
The nominal neutral interest rate is the level of the Official Cash Rate (OCR) consistent with inflation being sustainably at target and the economy running at its potential output. Without future shocks, the neutral interest rate indicates where the OCR is likely to settle to keep inflation at the 2% target midpoint.
More information
Read the speech: https://govt.us20.list-manage.com/track/click?u=bd316aa7ee4f5679c56377819&id=2920e70068&e=f3c68946f8
Watch the speech: https://govt.us20.list-manage.com/track/click?u=bd316aa7ee4f5679c56377819&id=e1dd2a8aa0&e=f3c68946f8
