Estimating Equilibrium Real Interest Rates in Real Time

Abstract

Abstract:We use a range of simple models and 22 years of real-time data vintages for the U.S. to assess the difficulties of estimating the equilibrium real interest rate in real time. Model specifications differ according to whether the time-varying equilibrium real rate is linked to trend growth, and whether potential output and growth are defined by the CBO's estimates or treated as unobserved variables. Our results reveal a high degree of specification uncertainty, an important one-sided filtering problem, and considerable imprecision due to data uncertainty. Also, the link between trend growth and the equilibrium real rate is shown to be quite weak. Overall, we conclude that statistical estimates of the equilibrium real rate will be difficult to use reliably in practical policy applications. Keywords:real-time-data; time-varying parameter; Kalman filter; trend growth JEL-Classification: C5, E4, C3, E52 Non Technical SummaryThe equilibrium real interest rate -the rate consistent with stable inflation and output equal to potential -has come to play a key role in monetary policy. For example, using a policy rule such as that suggested by Taylor (1993) to evaluate or guide policy requires an estimate of the equilibrium real rate, or natural rate of interest. According to basic economic theory, the equilibrium real rate is a function of the trend growth rate of output. If the trend growth rate varies over time, so, too, does the natural rate of interest. Some models or theories also link the equilibrium real interest rate to consumer preferences or fiscal policy.Prior studies have estimated the equilibrium real rate from models of the relationship between the output gap (the difference between actual and potential output) and real interest rates. These existing estimates of historical time series on the equilibrium real rate are based on the data available today. Over time, though, economic data are often substantially revised. For this and other reasons, estimates of the equilibrium real rate made in real time could differ substantially from estimates obtained with subsequently revised data.In this paper we use a range of simple models and 22 years of real-time data vintages for the United States to assess the difficulties of estimating the equilibrium real interest rate in real time. Our results reveal a high degree of uncertainty associated with the details of the model specification, considerable imprecision due to data uncertainty, and even more imprecision associated with having to base real time estimates on only past, rather than past and future, data. Moreover, the link between trend growth and the equilibrium real rate is shown to be quite weak. Overall, we conclude that statistical estimates of the equilibrium real rate will be difficult to use reliably in practical monetary policy applications. Nicht technische ZusammenfassungDer gleichgewichtige Realzins -der Zinssatz, der mit stabiler Inflation und einer dem

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