with figures in 2003 of somewhere between 5½ and 6¼ percent. at the same time, we have reduced our view on the neutral lending rate for households and businesses by less only about 1 percentage point. that is less than the drop in neutral 90 - day rates because of the significant increase in the spread between the two since the gfc. an implication of a lower neutral interest rate is that households and businesses will face lower interest rates “ on average ”, but this should not be read as a promise of lower interest rates all the time. interest rates will need to be adjusted in response to the state of the economy. for times when demand in the economy is expanding more rapidly than the economy ’ s ability to meet that demand interest rates will need to be above neutral. moreover, there is no reason to suppose how far interest rates move from trough to peak will be any different in the next business cycle than they moved in previous cycles. bis central bankers ’ speeches

for the rest of the talk i ’ ll only refer to the point estimate, but it should be taken as understood that there is always a band of uncertainty around our estimate of neutral. here i am talking about neutral nominal interest rates. however, for the rest of the discussion when i talk about the concept of neutral interest rates i will mean real neutral interest rates. therefore, if we were to assume inflation expectations are anchored at 2 percent, then the corresponding neutral real 90 - day interest rate would be 2½ percent. bis central bankers ’ speeches figure 2 real floating mortgage interest rates over a long horizon * source : rbnz * nominal interest rates deflated by cpi inflation economic theory tells us that changes in neutral interest rates reflect changes in real economic factors such as population growth, productivity growth, preferences for savings and also world conditions. 4 so it ’ s private preferences and opportunities that determine neutral – the neutral rate balances the choices of all participants in the market, on average over time. how can savings and investment decisions of new zealanders affect neutral interest rates? as a starting point, the interest rate can be thought of as the mechanism which reconciles the demand for funds ( consumption and investment ) with the supply of funds ( savings ). what we see is, in general, people put somewhat more value on consuming today than deferring consumption until tomorrow. this means a positive interest rate is required to encourage people to save today. in that context, the fact that new zealand interest rates normally tend to be higher than in some other advanced countries reflects new zealanders ’ tendency to invest more than we save. 5 as i have mentioned, interest rates can change over time. if there is a change in preferences so that people now have a greater desire to save today and consume tomorrow, a lower interest rate will be required to equate savings and investment. and if at the same time underlying preferences for investment remain unchanged, then we would generally expect the neutral interest rate to be lower. when the reserve bank sets the ocr, this affects other interest rates in the economy. we set the policy rate away from neutral when inflationary pressure is rising or falling, to slow or in classic models, such as ramsey or solow models, the neutral interest rate is associated with the long - run equilibrium interest rate. this is determined by factors such as productivity growth and household rate of time preference ( i. e. the strength with which households prefer to consume more now ). in new keynesian