Dynamics and Synchronization of Global Equilibrium Interest Rates

Abstract

With the COVID-19 pandemic, the intense debate about secular stagnation will become even more important. Empirical estimates of equilibrium real interest rates are so far mostly limited to advanced economies, since no statistical procedure suitable for a large set of countries is available. This is surprising, as equilibrium rates have strong policy implications in emerging markets and developing economies as well; current estimates of the global equilibrium rate rely on only a few countries; and estimates for a more diverse set of countries can improve understanding of the drivers. This paper proposes a model and estimation strategy that decompose ex ante real interest rates into a permanent and transitory component even with short samples and high volatility. This is done with an unobserved component local level stochastic volatility model, which is used to estimate equilibrium rates for 50 countries with Bayesian methods. Equilibrium rates were lower in emerging markets and developing economies than in advanced economies in the 1980s, similar in the 1990s, and have been higher since 2000. In line with economic integration and rising global capital markets, synchronization has been rising over time and is higher among advanced economies. Equilibrium rates of countries with stronger trade linkages and similar demographic and economic trends are more synchronized.

Neutral Real Interest Rates in Inflation Targeting Emerging and Developing Economies

“…Estimates of the neutral real interest rate in EMDEs in this paper are higher than those found in Beyer and Milivojevic (2020), the only other available estimates for this group of countries. In the latter, the 2019 estimate for EMDEs is 0.5 percent, compared to the over 2 percent estimated here.…”

“…Perrelli and Roache (2014b) also estimate neutral interest rates for emerging markets. Finally Beyer and Milivojevic (2020) estimate neutral real interest rates for 27 EMDEs using a univariate unobserved components model with stochastic volatility. In this paper, individual results for 20 EMDEs are aggregated using real GDP at 2010 prices and market exchange rates to generate an aggregate EMDE picture.…”

“…The neutral rate of interest is sometimes referred to as the natural or equilibrium rate of interest. 2 In the context of this paper this is a short-term concept that reflects the contemporaneous rate needed to achieve these objectives.3 Only Perrelli and Roache (2014b) andBeyer and Milivojevic (2020) analyze this many economies but using univariate filtering methods.…”