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Estimating the Indian natural interest rate and evaluating policy

Author

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  • Ashima Goyal

    (Indira Gandhi Institute of Development Research)

  • Sanchit Arora

    (Indira Gandhi Institute of Development Research)

Abstract

We estimate the unobserved time-varying natural interest rate (NIR) and potential output for the Indian economy using the Kalman Filter. Estimation is a special challenge in an emerging market because of limited length of data series and ongoing structural change. A key result in the literature is the NIR is imprecisely estimated. Structural aspects of the economy used in our estimation turn out, however, to improve the precision of the NIR estimates, although potential output continues to be imprecisely estimated. Turning points are well captured and estimates obtained for the output gap elasticity of aggregate supply and the interest elasticity of aggregate demand.The estimated NIR is used as an indicator of the monetary policy stance, which is found to be broadly contractionary and procyclical for the period under study.

Suggested Citation

  • Ashima Goyal & Sanchit Arora, 2013. "Estimating the Indian natural interest rate and evaluating policy," Indira Gandhi Institute of Development Research, Mumbai Working Papers 2013-017, Indira Gandhi Institute of Development Research, Mumbai, India.
    • Handle: RePEc:ind:igiwpp:2013-017
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    File URL: http://www.igidr.ac.in/pdf/publication/WP-2013-017.pdf
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    References listed on IDEAS

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    1. Ashima Goyal, 2009. "The Natural Interest Rate In Emerging Markets," World Scientific Book Chapters, in: Bhaskar Dutta & Tridip Ray & E Somanathan (ed.), New And Enduring Themes In Development Economics, chapter 15, pages 333-368, World Scientific Publishing Co. Pte. Ltd..
    2. Masao Ogaki & Jonathan D. Ostry & Carmen M. Reinhart, 1996. "Saving Behavior in Low- and Middle-Income Developing Countries: A Comparison," IMF Staff Papers, Palgrave Macmillan, vol. 43(1), pages 38-71, March.
    3. Thomas Laubach & John C. Williams, 2003. "Measuring the Natural Rate of Interest," The Review of Economics and Statistics, MIT Press, vol. 85(4), pages 1063-1070, November.
    4. Bhaskar Dutta & Tridip Ray & E Somanathan (ed.), 2009. "New and Enduring Themes in Development Economics," World Scientific Books, World Scientific Publishing Co. Pte. Ltd., number 7207, August.
    5. Goyal, Ashima, 2011. "A general equilibrium open economy model for emerging markets: Monetary policy with a dualistic labor market," Economic Modelling, Elsevier, vol. 28(3), pages 1392-1404, May.
    6. Jared Laxton & Igor Ermolaev & Charles Freedman & Mr. Ondrej Kamenik & Michel Juillard & Mr. Douglas Laxton & Ioan Carabenciov & Dmitry Korshunov, 2008. "A Small Quarterly Multi-Country Projection Model," IMF Working Papers 2008/279, International Monetary Fund.
    7. Glenn D. Rudebusch, 2001. "Is The Fed Too Timid? Monetary Policy In An Uncertain World," The Review of Economics and Statistics, MIT Press, vol. 83(2), pages 203-217, May.
    8. Mesonnier, Jean-Stephane & Renne, Jean-Paul, 2007. "A time-varying "natural" rate of interest for the euro area," European Economic Review, Elsevier, vol. 51(7), pages 1768-1784, October.
    9. Michel Juillard & Charles Freedman & Dmitry Korshunov & Mr. Douglas Laxton & Mr. Ondrej Kamenik & Ioan Carabenciov & Igor Ermolaev & Jared Laxton, 2008. "A Small Quarterly Multi-Country Projection Model with Financial-Real Linkages and Oil Prices," IMF Working Papers 2008/280, International Monetary Fund.
    10. Ashima Goyal & Shruti Tripathi, 2011. "New Keynesian aggregate supply in the tropics: food prices, wages and inflation," International Journal of Monetary Economics and Finance, Inderscience Enterprises Ltd, vol. 4(4), pages 330-354.
    11. Ashima Goyal & Sanchit Arora, 2012. "Deriving India's Potential growth from theory and structure," Indira Gandhi Institute of Development Research, Mumbai Working Papers 2012-018, Indira Gandhi Institute of Development Research, Mumbai, India.
    12. Masao Ogaki & Jonathan D. Ostry & Carmen M. Reinhart, 1996. "Saving Behavior in Low- and Middle-Income Developing Countries: A Comparison," IMF Staff Papers, Palgrave Macmillan, vol. 43(1), pages 38-71, March.
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    Cited by:

    1. Czeczeli, Vivien, 2023. "Az államadósság fenntarthatósága alacsony kamatkörnyezetben [The sustainability of public debt in a low interest rate environment]," Közgazdasági Szemle (Economic Review - monthly of the Hungarian Academy of Sciences), Közgazdasági Szemle Alapítvány (Economic Review Foundation), vol. 0(12), pages 1361-1388.
    2. Harendra Behera & Sitikantha Pattanaik & Rajesh Kavediya, 2015. "Natural Interest Rate: Assessing the Stance of India’s Monetary Policy under Uncertainty," Working Papers id:7654, eSocialSciences.
    3. Feng Zhu, 2016. "Understanding the changing equilibrium real interest rates in Asia-Pacific," BIS Working Papers 567, Bank for International Settlements.
    4. Feng Zhu, 2016. "A spectral perspective on natural interest rates in Asia-Pacific: changes and possible drivers," BIS Papers chapters, in: Bank for International Settlements (ed.), Expanding the boundaries of monetary policy in Asia and the Pacific, volume 88, pages 63-149, Bank for International Settlements.

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    More about this item

    Keywords

    Natural interest rate; potential output; Kalman filter; monetary policy;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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