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The Natural Rate of Interest and Convergence

Author

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  • Ertl, Martin
  • Rabitsch, Katrin

Abstract

We explore the natural rate of interest, shortly r*, in emerging economies. If economic growth originates from convergence, then growth, say, from technological progress will be lower than we find in the data and, hence, r* will be lower. Ignoring convergence upwardly biases our estimates of r*. We extend the New Keynesian small open economy model to incorporate convergence effects and estimate it using Bayesian techniques for four emerging economies in Central and Eastern Europe: Poland, Czech Republic, Hungary and Romania. Empirical evidence of the rapid catching-up of our sample economies during the period from 2003 to 2019 assists in specifying the model estimation. Our findings confirm a decline in r* over the past decades. Accounting for capital deepening reveals meaningful differences in estimated r*, with non-negligible implications for monetary policy in emerging economies.

Suggested Citation

  • Ertl, Martin & Rabitsch, Katrin, 2025. "The Natural Rate of Interest and Convergence," Department of Economics Working Paper Series 376, WU Vienna University of Economics and Business.
    • Handle: RePEc:wiw:wus005:72533822
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