Assessing the US and Canadian neutral rates: 2025 update

Overview

This note presents Bank of Canada staff’s current assessment of the US and Canadian neutral rates of interest. The neutral rate is where the Bank expects the policy rate would settle once output is at its long-run potential level and inflation is at target, after the effects of all cyclical shocks have faded (Mendes 2014). The Bank does not target the neutral rate, but it is an important input for the Bank’s economic projections.

We assess both the US and the Canadian nominal neutral rate to be in the range of 2.25% to 3.25%, unchanged from the 2024 range.

• In the United States, relative to the 2024 assessment, slower population growth and rising macroeconomic uncertainty are counterbalancing stronger productivity growth (see Boulanger et al. 2025).
• In Canada, in 2025, lower long-term population growth is partially offset by higher long-term productivity growth (see Abraham et al. 2025).

This year’s assessment considers two illustrative scenarios presented in the April 2025 Monetary Policy Report. These scenarios contain different assumptions about the future course of US trade policy. Scenario 1 assumes that orderly trade negotiations eliminate most of the recent tariff increases. Nevertheless, uncertainty and pessimism are expected to continue among businesses and households due to the previous on-again, off-again nature of US tariff threats. Scenario 2 assumes a long-lasting global trade war. It includes the same limited tariffs and uncertainty effects as the first scenario and adds the impacts of broad-based tariffs.

The neutral rate of interest is unobservable; it is inferred by assessing the evolution of the factors that influence it, such as potential output growth and the balance between global savings and investment. Measuring the neutral rate involves considerable uncertainty. Staff’s assessed ranges reflect the uncertainty inherent in the inputs used in the models, but they do not capture the full extent of uncertainties surrounding the neutral rate in the United States and Canada.

US neutral rate

The estimate of the US neutral rate—the Bank’s proxy for the global neutral rate—is based on the Bank’s view of US potential output growth and other factors that drive medium- to long-term savings and investment in the United States, particularly inequality, macroeconomic risk and government debt.

The 2025 assessment of the US nominal neutral rate is at the midpoint of a range from 2.25% to 3.25%. That range has not changed since the 2024 update (Adjalala et al. 2024). This assessment is robust to a range of impacts on US potential output growth from trade-related uncertainty and different possible trade policy outcomes, as discussed in Boulanger et al. (2025).

Assessment informed by a suite of models

Our assessment is informed by three models that take into account different drivers of the neutral rate:

• The overlapping-generations model (OLG), introduced in 2024 (Adjalala et al. 2024), has the richest structure and captures several key drivers of the US neutral rate, including productivity growth, demographic factors, government debt and inequality.
• The risk-augmented neoclassical growth model (RANCG) considers the tail risk channel, as explained in Bootsma et al. (2020).
• The term structure model extracts information from financial markets (Feunou, Fontaine and Krohn 2024).

US neutral rate unchanged relative to 2024

Table 1 presents the estimated range for the neutral rate from each model. Although the upper end of the range has increased for the OLG and RANCG models for 2025, the range presented in our 2024 assessment encompasses the 2025 midpoint estimates across all three models. Therefore, we believe the overall assessment range of 2.25% to 3.25% remains appropriate.

Table 1: Summary of estimates of the US nominal neutral policy rate

* The 2024 range reported here is based on a revised version of the term structure model and is not the same as that reported in Adjalala et al.’s 2024 assessment.
Note: Rates are in nominal terms. All estimates have been rounded to the nearest 25 basis points. Reported ranges are constructed methodologically based on different counterfactuals with respect to key inputs.

This assessment reflects the opposing effects of several drivers of the neutral rate. As described in Boulanger et al. (2025), the adoption of artificial intelligence is expected to lead to stronger productivity growth, which exerts upward pressure on the neutral rate. On the downside, in this year’s assessment, tighter US immigration policy and rising macroeconomic uncertainty are partially counterbalancing stronger productivity. In Scenario 2, the US neutral rate faces additional downward pressure from two factors: softer labour productivity growth and, to a lesser extent, a slightly weaker profile for the ratio of government debt to gross domestic product (GDP). The weaker debt-to-GDP ratio is based on the assumption that some of the tariff revenues are used to pay off government debt. However, these downward pressures are not large enough to shift the estimated range.

Canadian neutral rate

We assess that the nominal neutral rate in Canada currently lies in the range of 2.25% to 3.25%, unchanged from the April 2024 assessment. This assessment is robust to both trade-related scenarios.

On the domestic side, in both scenarios, a downward revision to long-term trend labour input (TLI) growth is partially offset by an upward revision to long-term trend labour productivity (TLP) growth. With estimates of the US neutral rate unchanged, the result is an unchanged assessment for Canada in both scenarios. Even in Scenario 2, where the level of potential output is permanently lower, the growth rate of potential output largely recovers after about three years once the economy has adjusted to reduced trade. Although efficiency losses lead to a permanently lower level of TLP, impacts on the long-term growth rate of TLP are assumed to be limited.

Table 2 summarizes the results of the three assessment methods we use to estimate the range for the Canadian neutral rate:1

• a term-structure model
• a risk-augmented neoclassical growth model
• an overlapping-generations model

Table 2: Summary of estimates of the Canadian nominal neutral rate

Note: Rates are in nominal terms. All estimates have been rounded to the nearest 25 basis points. Reported ranges are constructed based on different counterfactuals with respect to key inputs.

Term structure model

The term structure model provides estimates of the neutral rate for the United States and Canada using a two-country framework that integrates the exchange rate and bond markets (Feunou, Fontaine and Krohn 2024). Building on Bauer and Rudebusch (2020), the model imposes that currency risk premiums are tied to long-term trends in interest rate differentials; as a result, persistent yield differentials are embedded into exchange rate dynamics. This condition enables the model to capture the close linkage between currency and fixed-income markets across countries.

The increase of 75 basis points in the lower bound compared with the previous year’s estimate is attributed primarily to changes in the modelling approach and estimation procedure. We introduce an additional constraint on the relationship between cross-country interest rate differentials and currency risk premiums. In addition, the model now incorporates historical long-term interest rates to determine the initial estimation value. The resulting range of 2.75% to 3.25% is fully included within our overall assessment range.

Risk-augmented neoclassical growth model

The risk-augmented neoclassical growth model is a closed economy general equilibrium model with aggregate uncertainty. It includes only domestic factors that are assumed to affect households’ decisions on consumption and saving.2 Higher potential output growth per person, driven by both lower long-term population growth and higher productivity growth, implies upward pressure on the neutral rate. We keep our assumption for aggregate risk largely unchanged, as it already indicates a high perceived level of future economic uncertainty induced by the COVID-19 pandemic. The model suggests an upward revision of 25 basis points to the range, now at 2.50% to 3.00% for the nominal neutral rate in both scenarios.

Overlapping-generations model

This open economy general equilibrium model was described in detail in Kuncl and Matveev (2023). In the model, both international and domestic factors determine the neutral rate in Canada. A global neutral rate captures international factors. Domestic drivers that affect change in the Canadian neutral rate are:

• the growth rates of long-run labour input and productivity
• longevity
• government debt
• inequality

As in previous assessments, the US neutral rate serves as a proxy for the global neutral rate. Domestically, in both scenarios, weaker growth of long-term TLI is partially offset by stronger growth of long-term TLP. In the OLG model, population growth matters because of its impact on both the growth of the labour force and the composition of the labour force in terms of different age groups. A slower-growing population makes labour scarcer than capital, which increases the capital-to-labour ratio and exerts downward pressure on the neutral rate. This is offset by higher growth in long-run productivity, which applies upward pressure on the neutral rate. As a result, the model implies an unchanged range for the nominal neutral rate of 2.25% to 3.25%.

Assessment of the Canadian neutral rate

Overall, our suite of approaches implies an estimate for the Canadian neutral rate in a range of 2.25% to 3.25%. This estimate is unchanged from that in the 2024 assessment (Chart 1). In the absence of changes to the US neutral rate, the two main driving forces that balance each other are domestic factors:

• lower long-term population growth providing downward pressure
• higher long-term productivity growth providing upward pressure

We also consider the effects of structural changes to the drivers of the neutral rate. For example, if the United States were to further isolate its economy from the rest of the world, that would have implications for the link between the US and Canadian neutral rates. If Canadian borrowers had difficulty accessing funding in US capital markets or became increasingly reluctant to do so, they would need to borrow somewhere else—that is, Canadian foreign liabilities would need to be held by the rest of the world, at potentially less favourable terms. This would lead to an increase in the Canadian neutral rate. Moreover, if low confidence reflecting heightened risk to consumption growth were to persist into the long run, it would imply an increase in long-term precautionary savings. That would exert downward pressures on the Canadian neutral rate.

Conclusion

We assess the US and Canadian nominal neutral rates to be in the range of 2.25% to 3.25% in 2025, unchanged from the 2024 range of estimates.

Inevitably, uncertainty surrounds estimates of an unobservable variable such as the neutral rate of interest. While the ranges presented in this note reflect some of the sensitivity of our estimates to different models and their inputs, these ranges are narrower than what econometric models would suggest (Cacciatore, Feunou and Ozhan 2024).

References

Abraham, S., D. Brouillette, A. Chernoff, C. Hajzler, S. Houle, M. Kim and T. Taskin. 2025. “Potential Output in Canada: 2025 Assessment.” Bank of Canada Staff Analytical Note No. 2025-14.

Adjalala, F., F. Alves, H. Desgagnés, W. Dong, D. Matveev and L. Simon. 2024. “Assessing the US and Canadian Neutral Rates: 2024 Update.” Bank of Canada Staff Analytical Note No. 2024-9.

Bauer, M. D. and G. D. Rudebusch. 2020. “Interest Rates Under Falling Stars.” American Economic Review 110 (5): 1316–1354.

Bootsma, J., T. J. Carter, X. S. Chen, C. Hajzler and A. Toktamyssov. 2020. “2020 US Neutral Rate Assessment.” Bank of Canada Staff Discussion Paper No. 2020-12.

Boulanger, S., R. Dastagir, D. de Munnik, E. Ekanayake, K. Mo, W. Muiruri, F. Noor, S. Obaid and L. Poirier. 2025. “Assessing Global Potential Output Growth: April 2025.” Bank of Canada Staff Analytical Note No. 2025-15.

Cacciatore, M., B. Feunou and G. K. Ozhan. 2024. “The Neutral Interest Rate: Past, Present and Future.” Bank of Canada Staff Discussion Paper No. 2024-3.

Feunou, B., J.-S. Fontaine and I. Krohn. 2024. “Twin Stars: Neutral Rates and Currency Risk Premia.” Available at SSRN.

Kuncl, M. and D. Matveev. 2023. “The Canadian Neutral Rate of Interest through the Lens of an Overlapping-Generations Model.” Bank of Canada Staff Discussion Paper No. 2023-5.

Matveev, D., J. McDonald-Guimond and R. Sekkel. 2020. “The Neutral Rate in Canada: 2020 Update.” Bank of Canada Staff Analytical Note No. 2020-24.

Mendes, R. R. 2014. “The Neutral Rate of Interest in Canada.”  Bank of Canada Staff Discussion Paper No. 2014-5.

Endnotes

Acknowledgement

We thank Geoffrey Dunbar, Stefano Gnocchi, Marc-André Gosselin and Ben Tomlin for their insightful conversations and feedback. Amit Paul, Florent Samson and Argyn Toktamyssov provided useful inputs for the assessment of the neutral rates. We also thank Carole Hubbard and Meredith Fraser-Ohman for their editorial assistance and Joëlle Lefrançois-Couturier and Eric Bannem for their help translating this note into French.