Measuring the Natural Rate of Interest: International Trends and Determinants

Abstract

U.S. estimates of the natural rate of interest -the real short-term interest rate that would prevail absent transitory disturbances -have declined dramatically since the start of the global financial crisis. For example, estimates using the Laubach-Williams (2003) model indicate the natural rate in the United States fell to close to zero during the crisis and has remained there through the end of 2015. Explanations for this decline include shifts in demographics, a slowdown in trend productivity growth, and global factors affecting real interest rates. This paper applies the Laubach-Williams methodology to the United States and three other advanced economies -Canada, the Euro Area, and the United Kingdom. We find that large declines in trend GDP growth and natural rates of interest have occurred over the past 25 years in all four economies. These country-by-country estimates are found to display a substantial amount of comovement over time, suggesting an important role for global factors in shaping trend growth and natural rates of interest.

National natural rates of interest and the single monetary policy in the euro area

“…We obtain time-varying measures of the unobserved, latent variables in the model: the national natural rates of interest and the derived interest rate gaps, the national output gaps, and associated rates of potential output growth. We first find that the four national natural rates fluctuated widely around a globally declining trend over the last 15 years, a result consistent with the findings of Holston et al (2016). Cross-sectional averages indeed hovered between 3.5% in 2000 and −1.5% in 2012, finally to reach a level close to (but below) zero in 2016.…”

“…The persistence of low growth and low long-term real interest rates in major developed economies in the aftermath of the Great Recession has prompted a vivid debate about a possible downward shift in the level of the equilibrium, or "natural" real rate of interest (e.g., Hamilton, Harris, Hatzius, & West, 2015;Holston, Laubach, & Williams, 2016;Laubach & Williams, 2015;Rachel & Smith, 2015). The natural rate of interest, often denoted by r * , is conceptually an important benchmark for monetary policy.…”

Measuring the World Natural Rate of Interest

“…First, since our estimated value of the c parameter differs from what Laubach and Williams estimated for the United States, we explore the implications for our estimates of the world natural rate of simply setting the c parameter equal to the value estimated by Laubach and Williams. We also explore the implications of setting the value equal to 1, which would correspond to an assumption of log utility, and follow what Holston, Laubach, and Williams (2017) do in their international comparison of natural rate estimates. Second, we explore the implications of estimating the model in per capita terms given the significant variation in population growth rates that occurred over our sample period.…”

“…We assume that the world is fully integrated and ask the following questions: How has 1. See, for example, Laubach and Williams (2003), Clark and Kozicki (2005), Berger and Kempa (2014), Barsky, Justiniano, and Melosi (2014), Cúrdia et al (2015), Hamilton et al (2016), Pescatori and Turunen (2015), and Holston, Laubach, and Williams (2017). the world natural rate evolved over the past half century?…”

Testing for time variation in the natural rate of interest

“…Specifically, they use the median unbiased estimator proposed by Stock and Watson (1998), which is a sequential estimation procedure to account for the so-called pile-up problem. 1 Holston, Laubach, and Williams (2017;hereafter HLW) reestimate the NRI using a variant of the LW model with more recent data, and report that the US NRI has steadily declined over the past quarter century to historically low levels of close to zero. 2 In this paper we replicate in a wider sense the LW analysis utilizing the HLW data and methodology for the US economy.…”