Natural rates across the Atlantic

A closed-economy medium-scale model is estimated for the United States and the euro-area to assess the current level of the natural rate of interest and shed light on its drivers over the last decades. The model features a rich set of shocks that bear some connection with the explanations put forward in the literature to explain the secular downward trend in interest rates. The analysis shows that the natural rate has declined over the past decades, contributing to lowering nominal and real rates. Risk premium shocks, short-cut for changes in agents’ preference for safe assets, have been the main driver in the euro area. In the United States, shocks to the efficiency of investment, which may capture the functioning of the financial sector, and to the risk premium have played a major role. These differences between the two economies underscore the importance of adopting a structural model with a rich stochastic structure.