Estimating the natural rate of interest in an open economy

Abstract

The concept of the natural or equilibrium rate of interest has attracted a lot of attention from monetary policymakers in recent years. Most attempts to estimate the natural rate use a closed economy framework. We argue that in the face of greater integration of global product and capital markets, an open economy framework is more appropriate. We provide some initial estimates of the natural rate for the United States and Japan in a two-country framework. Our identifying assumptions include a close relationship between the time-varying natural rate of interest and the low-frequency fluctuations of potential output growth in both the home country and the foreign country. Our results suggest that the natural rates in both countries are mainly determined by their own trend growth rates of potential output. Nevertheless, the other country's trend growth plays an important role in several specific periods. The gap between the actual real interest rate and our estimated natural rate offers valuable insights into the recent stance of monetary policy in both of these two countries.

Measuring the World Natural Rate of Interest

“…A possible explanation to account for such a difference is that much of the z t for the U.S. natural rate is contributed by the trend growth of the rest of the world. Nevertheless, to further verify this possibility requires a two‐country model where the natural rate in the United States is determined by both home country trend growth and the foreign country trend growth as explored in Wynne and Zhang (forthcoming), which is beyond the discussion of this article.…”

Ties that Bind: Estimating the Natural Rate of Interest for Small Open Economies

“…Apart from that, semi-structural approaches may not su¢ ce to identify the structural driving forces behind the estimated natural rates. For the above-4 See, e.g., Clark and Kozicki (2005), Trehan and Wu (2007), Kiley (2015), Pescatori and Turunen (2015), for the U.S., Mesonnier and Renne (2007) and Fries et al (2018) for the euro area, Berger and Kempa (2014) for Canada, Armelius et al (2018) for Sweden, Neto and Candido (2018) for Brazil, Wynne and Zhang (2018a) for the U.S. and Japan, Holston et al (2017) for Canada, the euro area, the U.S., and the U.K, and Wynne and Zhang (2018b) for the world and so forth.…”

Ties that Bind: Estimating the Natural Rate of Interest for Small Open Economies

“…Apart from that, semi-structural approaches may not su¢ ce to identify the structural driving forces behind the estimated natural rates. For the above-4 See, e.g., Clark and Kozicki (2005), Trehan and Wu (2007), Kiley (2015), Pescatori and Turunen (2015), for the U.S., Mesonnier and Renne (2007) and Fries et al (2018) for the euro area, Berger and Kempa (2014) for Canada, Armelius et al (2018) for Sweden, Neto and Candido (2018) for Brazil, Wynne and Zhang (2018a) for the U.S. and Japan, Holston et al (2017) for Canada, the euro area, the U.S., and the U.K, and Wynne and Zhang (2018b) for the world and so forth.…”