Due to New Zealanders’ high inflation expectations, the Official Cash Rate (OCR) would currently need to be about 3.9% to neither tap the brakes nor push on the accelerator of the economy, the Reserve Bank’s new Bulletin article shows.
The current OCR at 5.5% is reducing capacity pressures and inflation in New Zealand.
Read the Bulletin article (PDF, 1.2MB)
When an investor considers their return on an investment, they are not merely interested in how many dollars they will receive in the future, but also how many goods and services they can purchase with those dollars. Therefore, their real rate of return can be calculated by subtracting expected future inflation from the nominal interest rate they invested at.
Likewise, it is the real NIR – the nominal NIR adjusted for inflation expectations – that matters for spending and investment decisions. However, the OCR is in nominal terms. So, to assess the stance of monetary policy, we need to adjust the real NIR for expected future inflation – from the short term, out to 10 years – to get an estimate of the nominal NIR.
Currently, with elevated inflation expectations, the “neutral” OCR is around 3.9%. This compares with the actual OCR of 5.5%, which is therefore clearly contractionary.
As inflation expectations continue to decline, a lower OCR would be considered a “neutral” rate. For example, our average of 5 different real NIR estimates adjusted to an average long-term nominal NIR suggest that an OCR of 2.5% would be neutral.
The OCR (green line) is reducing inflation in New Zealand.
