AI could push up the RBA’s neutral interest rate level
AI could raise Australia’s neutral interest rate level, making it harder for the Reserve Bank to cut lower interest rates further.
Where the neutral interest rate is (the level of interest rate that neither slows nor accelerates the economy) has been a hotly debated topic as investors speculate when the central bank will end its easing cycle.
Speaking on Wednesday, Penelope Smith, head of the RBA’s international department, said that while neutral interest rates around the world had been gradually falling until the COVID-19 pandemic, numerous forecasts since then suggested the neutral rate had remained steady or increased.
“Putting all this together leads to a very unsatisfactory conclusion: there is a lot of uncertainty about where neutral interest rates are and where they are going,” Dr Smith told the Australian Securitization Conference in Sydney.
“But perhaps we can conclude that they have not fallen since the pandemic and may even have risen.”
Central Bank Governor Michele Bullock has repeatedly emphasized that the RBA’s assessment of the neutral rate is uncertain.
If you take the midpoint of the RBA models for the neutral rate, this will give you a rate of 2.9 percent.
But Ms Bullock recently said the current 3.6 per cent cash rate, while slightly restrictive, was close to neutral.
If the neutral interest rate is higher than previously thought, this will make it difficult for the final interest rate to go lower without contributing to inflation.
Dr Smith said AI could increase the neutral rate if it resulted in higher productivity gains.
“Factors that could push neutral interest rates higher include growing fiscal deficits, reduced demand for safe assets in the event of post-crisis regulatory relaxation, or a sustained increase in productivity growth driven by artificial intelligence,” he said.
“At the same time, many of the factors that were suppressing neutral rates before the pandemic have not disappeared.
“Despite the optimism of AI, productivity growth outside the United States has remained weak and population aging will continue.”
He said further global fragmentation could potentially restrict capital mobility and reduce productivity growth, which could drive down the neutral rate.
The fact that asset prices remain high despite increased volatility suggests that investors place little weight on the risk of adverse events.
The RBA warned in its biannual check on Australia’s financial stability that the low asset risk premium could lead to a violent repricing in global financial markets if an unexpected shock occurs.
Dr Smith said market optimism around AI was one reason for the markets’ continued positivity.
He said a negative reassessment of the potential of AI could lead to a deterioration in global financial conditions.
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