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A Time-Varying Natural Rate for the Euro Area

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Author Info
Mésonnier, J-S.
Renne, J-P.

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Abstract

In this article we estimate a time-varying " natural " rate of interest (TVNRI) for a synthetic euro area over the period 1979Q1-2002Q4 using a small backward-looking macroeconomic model, broadly following a methodology developed by Laubach and Williams (2003) for the United States. The Kalman filter simultaneously estimates two unobservable variables: the output gap and the natural rate of interest. The underlying state-space model incorporates an aggregate demand equation and a Phillips curve. Consistent with the theoretical intuition, our identifying assumptions include a close relationship between the TVNRI and the low-frequency fluctuations of potential output growth. The resulting interest rate gap, that is, the difference between the real rate of interest and its estimated natural level, provides us with a valuable tool for assessing the monetary policy stance in EU12 over the last two decades. While our TVNRI estimate seems quite robust to changes in model specifications, the relatively high uncertainty surrounding the estimate hampers its direct integration into the policy-making process.

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Publisher Info
Paper provided by Banque de France in its series Documents de Travail with number 115.

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Length: 35 pages
Date of creation: 2004
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Handle: RePEc:bfr:banfra:115

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Related research
Keywords: Natural rate of interest ; Interest rate gap ; Monetary policy ; Kalman filter ; Output gap.;

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Find related papers by JEL classification:
C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Determination of Interest Rates; Term Structure of Interest Rates
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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