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Estimating Policy-Neutral Interest Rates for Canada Using a Dynamic Stochastic General Equilibrium Framework

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  • Jean-Paul Lam
  • Greg Tkacz

Abstract

In an era where the primary policy instrument is the level of short-term interest rates, comparing the level of such a rate relative to some equilibrium value can be a useful guide for policy and a convenient method to measure the stance of monetary policy. The real interest rate gap, the difference between the real equilibrium rate and the rate set by the central bank, can thus serve as a leading indicator of future inflationary or deflationary pressures in the economy. This paper estimates equilibrium interest rates for Canada using a sticky-price dynamic stochastic general equilibrium (DSGE) model. We follow the methodology of Neiss and Nelson (2003) closely and derive measures of the interest rate gap for Canada. Our results indicate that the interest rate gap can be a useful guide for policy and is a good an indicator of future output and inflation. Moreover, we find that our measures of the interest rate gap perform as well as the yield spread, a typical measure of policy stance which is assumed to contain significant information about future economic activity.

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Bibliographic Info

Article provided by Swiss Society of Economics and Statistics (SSES) in its journal Swiss Journal of Economics and Statistics.

Volume (Year): 140 (2004)
Issue (Month): I (March)
Pages: 89-126

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Handle: RePEc:ses:arsjes:2004-i-4

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Keywords: Interest rates;

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Cited by:
  1. Juan José Echavarría Soto & Enrique López Enciso & Martha Misas Arango & Juana Téllez Corredor & Juan Carlos Parra Alvarez, . "La Tasa de Interés Natural en Colombia," Borradores de Economia 412, Banco de la Republica de Colombia.
  2. Nicolas E. Magud & Evridiki Tsounta, 2012. "To Cut or Not to Cut? That is the (Central Bank’s) Question In Search of the Neutral Interest Rate in Latin America," IMF Working Papers 12/243, International Monetary Fund.
  3. Cour-Thimann, Philippine & Pilegaard, Rasmus & Stracca, Livio, 2006. "The output gap and the real interest rate gap in the euro area, 1960-2003," Journal of Policy Modeling, Elsevier, vol. 28(7), pages 775-790, October.
  4. Paul Castillo & Carlos Montoro & Vicente Tuesta, 2006. "Measuring the Natural Interest Rate for the Peruvian Economy," Working Papers 2006-003, Banco Central de Reserva del Perú.
  5. Berger, Tino & Kempa, Bernd, 2014. "Time-varying equilibrium rates in small open economies: Evidence for Canada," Journal of Macroeconomics, Elsevier, vol. 39(PA), pages 203-214.
  6. Roman Horvath, 2007. "The Time-Varying Policy Neutral Rate in Real Time: A Predictor for Future Inflation?," Working Papers 2007/4, Czech National Bank, Research Department.
  7. Rodrigo Fuentes S & Fabián Gredig U., 2008. "The Neutral Interest Rate: Estimates for Chile," Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 11(2), pages 47-58, August.

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