Measuring the Natural Rate of Interest

Abstract

A key variable for the conduct of monetary policy is the natural rate of interest -the real interest rate consistent with output equaling potential and stable inflation.Economic theory implies that the natural rate of interest varies over time and depends on the trend growth rate of output. In this paper we apply the Kalman filter to jointly estimate the natural rate of interest, potential output, and its trend growth rate, and examine the empirical relationship between these estimated unobserved series. We find substantial variation in the natural rate of interest over the past four decades in the United States. Our natural rate estimates vary about one-for-one with changes in the trend growth rate. We show that policymakers' mismeasurement of the natural rate of interest can cause a significant deterioration in macroeconomic stabilization.JEL classification: C32, E43, E52, O40.Keywords: natural rate of interest, interest rate rules, Kalman filter, trend growth, potential output, equilibrium real interest rate.

The productivity gap: Monetary policy, the subprime boom, and the post-2001 productivity surge

“…Ferguson then went on to observe that rapid productivity growth was "a powerful force tending to make the equilibrium real rate higher than it would otherwise be," while noting how Laubach and Williams' (2003) estimate of the real neutral rate placed it at 3 percent as of mid-2002, a value close to with our own crude estimate. Yet instead of concluding that the Fed's policy stance had been excessively easy, Ferguson defended that stance by citing conditions supposedly warranting departures from a neutral policy.…”

“…Total factor productivity estimates are from Fernald (2009) while output gap estimates are from Laubach and Williams (2003). The federal funds rate, CPI, unemployment rate, and housing starts are from the St. Louis Fed's FRED Database at the St. Louis Federal Reserve Bank.…”

Identification-Robust Estimates of the Canadian Natural Rate of Interest

“…For example, Laubach-Williams(2003) suggest that, for the US, this rate declined from 4.5 percent in the mid-sixties to around 2.5 percent in the mid-seventies. However Clark-Kozicki(2005) document some important difficulties in obtaining precision of estimates for a time-varying natural rate, particularly when the variation in the latter is related to changes in the trend growth rate.…”

The natural rate of interest in Brazil between 1999 and 2005

“…In an attempt to provide an alternative solution to this problem, Leigh (2005) estimated a dynamic reaction function for the U.S. economy, where the natural rate of interest was no longer a constant, but a variable intercept of the function instead. To accomplish that, the author separately estimated the natural rate using the method proposed by Laubach and Williams (2003), later obtaining a reaction function where the natural rate was a time-varying parameter.…”

“…Then, an estimation of a dynamic Taylor rule is performed. These two estimates are eventually compared with the natural rate of interest obtained from a simplified macroeconomic state-space model following Laubach and Williams (2003 …”