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Two tales of the natural rate of interest

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  • Vilmi, Lauri

Abstract

We estimate the long-term natural rate of interest for the euro area with two specifications of a simple semi-structural macroeconomic model. The estimates provide competing interpretations for the euro area’s current economic environment of weak growth, subdued inflation and exceptionally low nominal interest rates. In our first estimation, the current state of economy is attributed to persistent, recurring negative shocks to the output gap that restrain growth even when expansionary monetary policies are applied. The second estimation suggests that a large drop in the natural rate of interest is the problem, because, even with interest rates held close to zero, policy actions have not been able to revive the economy after major shocks in 2008, 2012 and 2016. As both views may explain some of the observed trends, the task of teasing out the drivers of current conditions and future trends is non-trivial. Nevertheless, policymakers should pay attention to both stories as they have quite different endings.

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  • Vilmi, Lauri, 2017. "Two tales of the natural rate of interest," BoF Economics Review 1/2017, Bank of Finland.
    • Handle: RePEc:zbw:bofecr:12017
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    Cited by:

    1. Darracq Pariès, Matthieu & Notarpietro, Alessandro & Kilponen, Juha & Papadopoulou, Niki & Zimic, Srečko & Aldama, Pierre & Langenus, Geert & Alvarez, Luis Julian & Lemoine, Matthieu & Angelini, Elena, 2021. "Review of macroeconomic modelling in the Eurosystem: current practices and scope for improvement," Occasional Paper Series 267, European Central Bank.

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    More about this item

    Keywords

    euro area monetary policy; natural rate of interest;

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • 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
    • O40 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - General

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