RBA plagued with uncertainty on the neutral cash rate
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The news: The RBA is struggling to determine the trajectory of the neutral cash rate, the hypothetical rate at which monetary policy is neither restrictive or loose, but suggests it could be on the rise.
The context: RBA head of international department Penelope Smith told the Australian Securitisation Conference in Sydney on Wednesday that "there is a lot of uncertainty about where neutral rates are and where they are going”.
At the very least, Smith said neutral rates “have not fallen since the pandemic and may have even risen”.
She flagged several factors that could push neutral rates higher such as “growing fiscal deficits, a decline in the demand for safe assets if there is a loosening of post-crisis regulation, or a sustained increase in productivity growth arising from AI”.
However, she flagged that “many of the factors that depressed neutral rates before the pandemic have not gone away” with AI yet to boost a prolonged deceleration in productivity growth and the population still ageing.
It is also unclear to what extent “greater global fragmentation” through trade wars and a risk of regulatory divergence in the international financial system for banking and digital assets will have on the trajectory of neutral rates in Australia.
What they said: “While it could lower productivity growth, pulling neutral down, it could also restrict capital mobility from high-saving emerging markets, putting upward pressure on neutral rates in advanced economies like Australia,” Smith said.
Previous studies have suggested that the US neutral rate “can explain most of the influence of global factors on Australia’s neutral rate”, consistent with the US’ historically central role in the international financial system.
The source: RBA speech
