TAILIEUCHUNG - What is the neutral real interest rate, and how can we use it?

Meanwhile, the share of auto loans in the total loan portfolio dropped to in the fourth quarter of 2007, from in the previous quarter. The ratio of past-due auto loans to total auto loans was maintained at in the fourth quarter of 2007, little changed from the third quarter, as the climb in past-due auto loans to PHP billion nearly matched the growth in total auto loans. Nonetheless, the ratio was slightly lower in the first quarter of 2008 than in the first quarter of 2007 (), as the hike in past-due auto loans. | What is the neutral real interest rate and how can we use it Joanne Archibald and Leni Hunter Economics Department1 This article sets out the Reserve Bank s conception of the neutral real interest rate and identifies factors that influence its level. These factors provide a starting point for thinking about what might cause the neutral real interest rate to change over time or differ across countries. We consider the uses and limitations of neutral real interest rates in answering some of the questions that are relevant to monetary policy and present a range of estimates of the neutral real interest rate for New Zealand. 1 Introduction The focus of this article is the neutral real interest rate. In order to understand the concept of a neutral real interest rate it is first necessary to understand what we mean by the term real interest rate . The interest rates that we observe in day-to-day life are almost always expressed in nominal terms. For example if an investor has money in a savings account the nominal interest rate tells the investor how much money the bank will pay them as a return on their savings. The nominal interest rate does not tell the investor how much the return on their savings will be worth in terms of actual goods and services. To find this out the investor would need to adjust the nominal return on their savings by the amount by which they think prices will change during the time when their money is held in their savings account. In other words to determine the expected real interest rate the investor would need to subtract the expected inflation rate from the nominal interest rate. Assuming that we care about the quantity of goods and services that we can buy with money rather than money itself it would seem reasonable to suppose that it is the real interest rate rather than the nominal interest rate that drives our economic decisions. For many central banks including the Reserve Bank of New Zealand the policy instrument that the central bank

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