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Estimating the natural interest rate for the euro area and Luxembourg

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Author Info

  • Ladislav Wintr

    ()

  • Paolo Guarda

    ()

  • Abdelaziz Rouabah

    ()

Abstract

This paper estimates the natural real interest rate that is consistent with stable inflation and output at its potential for the euro area and Luxembourg. The natural interest rate provides a benchmark for assessing the monetary policy stance, as policy is contractionary when real interest rates rise above the natural rate and expansionary when real interest rates fall below this level. We follow Laubach and Williams (2003) in using a small backward-looking macroeconomic model to estimate the time-varying natural interest rate as an unobservable variable. For the euro area, our results suggest the natural interest rate has been fairly stable since 1970 and confirm its decline over the last decade. For Luxembourg, our estimate of the natural interest rate is much higher, reflecting higher potential growth. The results suggest that the single monetary policy may have had an expansionary impact in recent years, especially in Luxembourg.

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File URL: http://www.bcl.lu/fr/publications/cahiers_etudes/15/BCLWP015.pdf
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Bibliographic Info

Paper provided by Central Bank of Luxembourg in its series BCL working papers with number 15.

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Length: 27 pages
Date of creation: Jun 2005
Date of revision:
Handle: RePEc:bcl:bclwop:bclwp015

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Web page: http://www.bcl.lu/

Related research

Keywords: Kalman filter; natural interest rate equilibrium; real interest rate;

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References

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  1. Athanasios Orphanides & John C. Williams, 2002. "Robust monetary policy rules with unknown natural rates," Working Paper Series 2003-01, Federal Reserve Bank of San Francisco.
  2. Jean-Stephane Mesonnier & Jean-Paul Renne, 2004. "A Time Varying Natural Rate of Interest for the Euro Area," Money Macro and Finance (MMF) Research Group Conference 2004 42, Money Macro and Finance Research Group.
  3. Thomas Laubach, 2001. "Measuring The NAIRU: Evidence From Seven Economies," The Review of Economics and Statistics, MIT Press, vol. 83(2), pages 218-231, May.
  4. Glenn D. Rudebusch & Lars E. O. Svensson, 1998. "Policy rules for inflation targeting," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  5. Kuttner, Kenneth N, 1994. "Estimating Potential Output as a Latent Variable," Journal of Business & Economic Statistics, American Statistical Association, vol. 12(3), pages 361-68, July.
  6. Katharine S. Neiss & Edward Nelson, 2001. "The real interest rate gap as an inflation indicator," Bank of England working papers 130, Bank of England.
  7. Clark, Todd E. & Kozicki, Sharon, 2005. "Estimating equilibrium real interest rates in real time," The North American Journal of Economics and Finance, Elsevier, vol. 16(3), pages 395-413, December.
  8. Robert J. Gordon, 1996. "The Time-Varying NAIRU and its Implications for Economic Policy," NBER Working Papers 5735, National Bureau of Economic Research, Inc.
  9. Clark, Peter K., 1989. "Trend reversion in real output and unemployment," Journal of Econometrics, Elsevier, vol. 40(1), pages 15-32, January.
  10. John C. Williams, 2003. "The natural rate of interest," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue oct31.
  11. 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.
  12. Jesús Cuaresma & Ernest Gnan & Doris Ritzberger-Gruenwald, 2004. "Searching for the natural rate of interest: a euro area perspective," Empirica, Springer, vol. 31(2), pages 185-204, June.
  13. Peersman, Gert & Smets, Frank, 1999. "The Taylor Rule: A Useful Monetary Policy Benchmark for the Euro Area?," International Finance, Wiley Blackwell, vol. 2(1), pages 85-116, April.
  14. Watson, Mark W., 1986. "Univariate detrending methods with stochastic trends," Journal of Monetary Economics, Elsevier, vol. 18(1), pages 49-75, July.
  15. Smets, Frank & Wouters, Raf, 2002. "An estimated stochastic dynamic general equilibrium model of the euro area," Working Paper Series 0171, European Central Bank.
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Citations

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Cited by:
  1. Belke, Ansgar & Klose, Jens, 2013. "Modifying Taylor reaction functions in the presence of the zero‐lower‐bound — Evidence for the ECB and the Fed," Economic Modelling, Elsevier, vol. 35(C), pages 515-527.
  2. Horváth, Roman, 2009. "The time-varying policy neutral rate in real-time: A predictor for future inflation?," Economic Modelling, Elsevier, vol. 26(1), pages 71-81, January.
  3. Ansgar Belke & Jens Klose, 2010. "(How) Do the ECB and the Fed React to Financial Market Uncertainty? – The Taylor Rule in Times of Crisis," Ruhr Economic Papers 0166, Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Ruhr-Universität Bochum, Universität Dortmund, Universität Duisburg-Essen.
  4. Horvath, Roman, 2006. "Real-Time Time-Varying Equilibrium Interest Rates: Evidence on the Czech Republic," MPRA Paper 845, University Library of Munich, Germany.

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