Neutral Madness

By Alan Kohler | More Articles by Alan Kohler

There was a bout of pure silliness this week after the Reserve Bank put out the minutes of its June board, including discussion of the “neutral cash rate” – that is, the goldilocks rate, at which inflation and unemployment are both low and stable.

It was tentatively estimated in the minutes to be 3.5%, with the rider that “there is significant uncertainty around this estimate”.

Reading the minutes, it’s clear that the point they were making is that the neutral rate has fallen (they think):

“The various estimates suggested that the (real) rate had been broadly stable until around 2007, but had since fallen by around 150 basis points to around 1 per cent. This equated to a neutral nominal cash rate of around 3½ per cent…

“Members noted that some of this decline could be attributed to lower potential output growth, but the increase in risk aversion around the time of the global financial crisis was likely to have been a more important factor, given that the bulk of the decline in the estimated neutral real interest rate had occurred around that time. Estimates of neutral real interest rates for other economies had shown a similar decline.”

Wait a minute, said commentators and market traders, that’s 2% above what the cash rate is now! The dollar spiked. Pet shop galahs started talking about higher rates. Even the Prime Minister joined in, warning everyone to get ready.

Of course interest rates will eventually rise again! No one knows when, or by how much, including the RBA brains trust and the Prime Minister, but they certainly won’t stay at this record low level forever.

And the only point that the RBA was making in the minutes is that interest rates are unlikely to rise to levels seen in the past, because what’s normal – or “neutral” – has changed.

The Australian dollar is sitting in the mid 79s not because interest rates here are about to rise by 2% (they’re not) but because the US dollar is weak.

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About Alan Kohler

As well as being the founder of The Constant Investor, Alan is currently business editor at large of The Australian, finance presenter on ABC news, presenter of the Talking Business channel on Qantas inflight radio and adjunct professor in the business faculty of Victoria University.

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