Dmitry Butrin’s column on the increase in the Central Bank’s estimates of the neutral level of the rate

Last week, in the draft “Guidelines for the Unified Monetary Policy (MP)”, the Bank of Russia published the preliminary results of internal and external discussions as part of the final MP review on the neutral level of interest rates in the Russian economy. A purely technical conclusion from this discussion was known as early as July 2023: in the latest, July version of the Central Bank’s macro forecast, the neutral rate range was estimated at 5.5–6.5%, that is, 0.5 percentage points higher than in recent years . According to our assumptions, this played an important role in the fact that the Bank of Russia raised the key rate by 100 points in July, significantly higher than the market expected from it. For an inflation targeting regime, a neutral interest rate is, in fact, a fundamental concept. Plus, the Bank of Russia will repeat this logic, in the framework of monetary policy, non-linearly and indirectly correlating its decisions with the assessment of the neutral rate (recall, the short-term neutral level of the rate is practically indeterminate).

In a strong simplification, the nominal neutral rate (consisting of the real neutral rate and inflation) is the hypothetical level of the Central Bank’s key rate, at which the dynamics of GDP is equal to potential GDP with optimally low “natural” unemployment. That is, this is the level of average rates in a perfectly balanced economy over a long time period, and in this sense it can be considered something like a “fair price of money” or a “natural credit rate”, if we are ready to talk about fairness and naturalness in the financial sense, which should be done only with very big reservations. The sidebar in the Main Directions, dedicated to this unobservable indicator, lists in detail the attempts of independent economists to estimate it for the Russian Federation since 2016 – in various works it was estimated (in real terms, minus inflation) at 1–3%, however, some calculations in general showed it negative. Nevertheless, it is not so much the rate that is important as its dynamics. As the Central Bank states, three factors have influenced the real neutral rate (before that, it probably decreased) in recent years (covid plus sanctions after the start of the Russian military operation in Ukraine). The first is the decline in GDP growth potential: this is a factor in favor of lowering the estimate of the neutral rate. The second is the country risk: it has certainly increased, it has increased the rate. The third is world neutral rates: they have risen.

We are primarily interested in the contribution of the first and second components. We can draw a rough but realistic conclusion: the events of 2022-2023 have created new country risks corresponding to a 1-2% increase in the long-term value of money in the economy, hardly more. Is it a lot or a little? We do not know, but it was assumed that the revaluation “up” would be higher.