Neutral interest rate (r-star)

What is the neutral rate?

The neutral interest rate is the interest rate at which monetary policy neither pushes the economy to grow faster nor holds it back, while inflation stays stable.

Economists also call it r-star (written r*) or the natural rate of interest. It is a theoretical level that cannot be observed directly, so it is always an estimate.

Formal definition

In formal terms, r* is the real short-term interest rate consistent with output at its potential level and stable inflation, once temporary shocks have faded. "Real" means adjusted for inflation:

• Real policy rate = nominal policy rate − expected inflation
• Nominal neutral rate = r* + expected inflation (or the inflation target)

A central bank compares its policy rate with this benchmark:

Worked example

The State Bank of Pakistan's most recent decision reads: SBP policy rate raised by 50 bps to 12% with effect from 27.10.2026 (MPC). The change is quoted in basis points.

Here is a hypothetical case to show how analysts use r*:

1. Subtract expected inflation from the policy rate to get the real policy rate.
2. Compare that real rate with an estimate of Pakistan's r*.
3. If the real rate is above the estimate, commentators describe policy as restrictive. If it is below, they call it accommodative.

Different models give different estimates of r*. As a result, the same policy rate can look tight to one analyst and neutral to another.

Where the term appears

• Central bank statements and reports. Monetary policy statements and research papers discuss whether the real rate is "positive" or "restrictive". Some central banks publish a longer-run rate projection that works as a stand-in for the nominal neutral rate.
• News and analyst notes. Writers use phrases such as "rates are above neutral" or "the neutral rate has risen" to explain why a central bank may pause, cut or hike.
• Trading platforms. The economic calendars found in many MetaTrader setups list rate decisions. They do not show r* itself. Traders bring in the neutral-rate view through fundamental analysis.

Edge cases and limits

• Not observable. r* is inferred from models, such as the Laubach–Williams approach. The error bands around these estimates are wide.
• It moves over time. Demographics, productivity, savings and global capital flows can shift r* slowly.
• Short run vs long run. Some analysts separate a short-run neutral rate, which shifts with current shocks, from a long-run anchor.
• Open economies. In countries like Pakistan, the exchange rate, country risk premiums and external financing needs affect what "neutral" means. This is why rate gaps link to covered interest parity and currency appreciation.
• Not a trading signal. A gap between the policy rate and r* does not predict a price move. Leveraged forex and CFD trading built on such views can lose money fast.

Related terms

• Basis point
• Business cycle
• Disinflation and deflation
• Swap fees: overnight financing linked to interest rate differences
• Currency pairs
• Trading glossary

Frequent questions

Is r-star the same as the policy rate?

No. The policy rate is set by the central bank. r* is an estimated benchmark used to judge whether the policy rate is tight or loose.

Who calculates the natural rate of interest?

Central bank researchers, academics and private analysts calculate it with economic models. No single official figure exists, and estimates often differ.

Why do traders care about the neutral rate?

It frames expectations about future rate changes. Those expectations affect currencies, bonds and indices. It is context, not a forecast.

Can the neutral rate be negative?

In real terms, yes. Some estimates for advanced economies have been below zero in periods of weak growth and low inflation.