Assessing drivers of New Zealand’s natural rate of interest using an overlapping generations model

We build a small open economy overlapping-generations model (SOE-OLG) to understand changes in the natural rate of interest in New Zealand over the period 2000–2024. We consider six drivers of the natural rate of interest: the world natural rate of interest, population growth, productivity growth, government debt levels, old-age labour force participation and longevity. We find that declining productivity growth and a lower world natural rate of interest are important for explaining the reduction in the New Zealand natural rate of interest, only partially offset by higher population growth, and to a lesser degree by increasing old-age labour force participation. The role of changes in government debt levels and longevity have been modest, with the change in these drivers over our analysis period being relatively small. Our results are based on defining the natural rate of interest as the long-run equilibrium real interest rate. In the model, the domestic natural rate of interest is equal to the world natural rate of interest plus a premium. The size of this premium reflects the difference between domestic capital stock and domestic savings, which is the net foreign position.