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Searching for the natural rate of interest: a euro area perspective

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  • Jesús Cuaresma
  • Ernest Gnan
  • Doris Ritzberger-Gruenwald
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    Abstract

    A time-varying natural rate of interest is estimated for the euro area using a multivariate unobserved components model. The problem of aggregating interest rate data for the pre-EMU period is directly addressed, and a simple method is proposed in order to adjust the risk premia in the interest rate data prior to 1999. We show that, for the pre-EMU period, using risk-unadjusted policy rates leads to periods of high risk premia being erroneously taken as monetary policy replies to the output gap; in contrast, using risk-adjusted policy rates yields an estimate of the reaction of monetary policy to the output gap corresponding approximately to an increase of 40 basis points for a 1%positive deviation of output from potential output. A positive deviation of inflation from its trend of 1%is estimated to have triggered an approximately 1.2%increase in short-term interest rates. Copyright Kluwer Academic Publishers 2004

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    Bibliographic Info

    Article provided by Springer in its journal Empirica.

    Volume (Year): 31 (2004)
    Issue (Month): 2 (June)
    Pages: 185-204

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    Handle: RePEc:kap:ecopln:v:31:y:2004:i:2:p:185-204

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    Web page: http://www.springerlink.com/link.asp?id=113294

    Related research

    Keywords: Natural rate of interest; unobserved components models; monetary policy; Taylor rule;

    References

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    1. Neiss, Katharine & Nelson, Edward, 2001. "The Real Interest rate Gap as an Inflation Indicator," CEPR Discussion Papers 2848, C.E.P.R. Discussion Papers.
    2. Harvey, A C & Jaeger, A, 1993. "Detrending, Stylized Facts and the Business Cycle," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 8(3), pages 231-47, July-Sept.
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    14. 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.
    15. Bomfim, Antulio N, 1997. "The Equilibrium Fed Funds Rate and the Indicator Properties of Term-Structure Spreads," Economic Inquiry, Western Economic Association International, vol. 35(4), pages 830-46, October.
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    17. Hans Christiansen & Charles Pigott, 1997. "Long-Term Interest Rates in Globalised Markets," OECD Economics Department Working Papers 175, OECD Publishing.
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