Neutral interest rate in Hungary

Central banks primarily achieve their inflation targets by changing their key instrument, the central bank base rate, to the required extent and with careful timing. If the inflation outlook deteriorates and the forward-looking inflation rate exceeds the target, monetary policy raises interest rates to cool the economy and reduce inflation. In the opposite scenario, the bank cuts interest rates to stimulate the economy and raise inflation. In order to decide whether the prevailing rate of interest stimulates or slows the economy, it is necessary to know where the interest rate threshold is for expansionary versus contractionary monetary policy. We call this point of reference the neutral interest rate or the natural rate of interest. Similar to potential output, the neutral interest rate is a theoretical equilibrium concept, not an observable variable. It is therefore difficult to grasp empirically and its point estimation is surrounded with a great degree of uncertainty. This essay looks at the individual factors influencing the neutral interest rate and gives an estimate for the range in which it may move in Hungary.