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The Neutral Rate of Interest in Canada

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  • Rhys R. Mendes

Abstract

A measure of the neutral policy interest rate can be used to gauge the stance of monetary policy. We define the neutral rate as the real policy rate consistent with output at its potential level and inflation equal to target after the effects of all cyclical shocks have dissipated. This is a medium- to longer-run concept of the neutral rate. Under this definition, the neutral rate in Canada is determined by the longer-run forces that influence savings and investment in both the Canadian and global economies. Structural forces have likely reduced the neutral rate by more than a percentage point since the mid-2000s. The Bank’s estimates of the real neutral policy rate currently stand in the 1 to 2 per cent range, or 3 to 4 per cent in nominal terms. The current gap between the policy rate and the neutral rate reflects policy stimulus in response to significant excess supply and in the face of continuing headwinds. As long as these headwinds persist, a policy rate below neutral will be required to maintain inflation sustainably at target.

Suggested Citation

  • Rhys R. Mendes, 2014. "The Neutral Rate of Interest in Canada," Discussion Papers 14-5, Bank of Canada.
    • Handle: RePEc:bca:bocadp:14-5
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    References listed on IDEAS

    as
    1. Gregory Bauer & Antonio Diez de los Rios, 2012. "An International Dynamic Term Structure Model with Economic Restrictions and Unspanned Risks," Staff Working Papers 12-5, Bank of Canada.
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    3. José Dorich & Michael K. Johnston & Rhys R. Mendes & Stephen Murchison & Yang Zhang, 2013. "ToTEM II: An Updated Version of the Bank of Canada’s Quarterly Projection Model," Technical Reports 100, Bank of Canada.
    4. Dean Baker & J. Bradford Delong & Paul R. Krugman, 2005. "Asset Returns and Economic Growth," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 36(1), pages 289-330.
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    More about this item

    Keywords

    Interest rates; Transmission of monetary policy;

    JEL classification:

    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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