The Neutral Real Interest Rate

Abstract

The concept “neutral real interest rate” is generally associated with the real interest rate level, which implies that monetary policy is neither expansionary nor contractionary. We define the neutral real interest rate as the real interest rate level which in the medium term is consistent with a closed output gap. We consider in more detail how the neutral real interest rate in a small, open economy is influenced by global conditions. The neutral real interest rate cannot be observed, and estimates are uncertain. Different methods for estimating the neutral real interest rate are presented in this article. An overall assessment implies that it will normally lie in the range of about 2½–3½ per cent in Norway. In recent years, with low real interest rates globally, we cannot exclude the possibility that the neutral real interest rate in Norway may be even lower. The neutral real interest rate has probably been falling since the 1980s and early 1990s, partly as a result of lower inflation risk premia.