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

and the means to achieve the desired results. the fundamental objectives of economic development in our country remain the same : growth and social justice. instrumentalities to achieve these will have to change in tune with our experience and according to the demands of the time and the responses of the society. in bringing about faster growth we need to address many issues. perhaps one that is most relevant in the context of work that is going on at iima is the issue of productivity. in ensuring a higher growth rate, there is no doubt that we must bring about an increase in the saving rate and, consequently, the investment rate. but at the same time one cannot over - emphasise the need for improving the productivity and efficiency of input use. economists in fact talk about total factor productivity, which identifies the contribution to the increase in output of influences other than increase in factor inputs. the total factor productivity growth thus encompasses the effect not only of technological progress but also of better utilisation of capacities, improved skills of labour, etc. in fact during the period 1960 - 87 the total factor productivity growth of east asia was 1. 9 per cent per productivity and efficiency. contrary to the general impression, the natural resources of our country are not large. from the point of view of long - range sustainability, the need for greater efficiency in the management of natural resources of land, water, minerals, etc. has become urgent. in a capital - scarce economy like ours, there can be no excuse for under - utilisation of capacity. macro - policy framework and micro - management practices must be such as to bring about the desired increase in productivity. while the policy framework must be supportive, industrial structure must be such as to compel firms to continually innovate and to cut costs. the policy environment, the organisational structure and the attitude to work and technology : all these have to be right. needless to say, institutes of management have an important role to play in bringing about this improvement in productivity by sharpening the skills and the vision of managers. - 2the recent development experience has clearly shown that countries which have grown fast are those which have made very heavy investment in education. even as we aim at creating a broad - based educational system, including compulsory education at the primary and secondary levels, we also need institutions of excellence. living as we are in a complex and globally competitive world, institutions of excellence in all disciplines are required to meet the challenges of competition, which in effect is the competition in skills