Neutral rate of interest
Also called: r-star, r*, Natural rate of interest · Topic: Banking, Credit Creation and Monetary Policy · NCERT: Beyond NCERT
Meaning
The neutral rate of interest, also written r ("r-star"), is the real interest rate at which the economy stays at its potential output and inflation stays stable. At this rate, policy neither speeds up nor slows down the economy. The real rate is roughly the nominal rate minus expected inflation. If the real policy rate is above r, policy is tight. If it is below r*, policy is loose. The neutral rate cannot be seen directly, so it has to be estimated. The RBI puts it at about 1.4-1.9%.
Example
After Dec 2025, the repo rate was 5.25% and inflation was about 4%. This gave a real rate of about 1.25%. That is slightly below the RBI's estimated range of 1.4-1.9%, so policy was mildly supportive of growth.
Don't confuse with
- Repo rate: the repo rate is a nominal rate that the RBI sets. The neutral rate is a real rate. It is an estimate used to judge whether the policy rate is tight or loose.
Related concepts
- Inflation targeting
- Flexible inflation targeting
- Monetary Policy Committee
- Monetary policy stance
- Central bank independence
- Fiscal dominance
- Taylor rule