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Econometric issues in the estimation of the natural rate of interest

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  • Buncic, Daniel

Abstract

The natural rate of interest is a key benchmark steady-state rate of return that is used by central banks to measure the stance of monetary policy. Asset managers rely on estimates of the natural rate to make long-term investment decisions for their clients. This paper outlines a number of important econometric issues in the estimation of the natural rate of interest from a widely used structural model. Using a simulation experiment as well as empirical data for the U.S., I show that one of the key parameters of the structural model is overestimated and leads to a spuriously amplified downward trend in the natural rate. The paper shows how the overestimation can be remedied and provides alternative estimates of the natural rate. Various other issues are discussed that policy makers should be aware of when utilizing this model’s natural rate estimates for policy decision.

Suggested Citation

  • Buncic, Daniel, 2024. "Econometric issues in the estimation of the natural rate of interest," Economic Modelling, Elsevier, vol. 132(C).
    • Handle: RePEc:eee:ecmode:v:132:y:2024:i:c:s0264999323004534
    DOI: 10.1016/j.econmod.2023.106641
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    References listed on IDEAS

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    1. repec:rim:rimwps:18-29 is not listed on IDEAS
    2. Daniel Buncic & Adrian Pagan, 2022. "Discovering Stars: Problems in Recovering Latent Variables from Models," CAMA Working Papers 2022-52, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
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    8. Daniel Buncic, 2021. "On a Standard Method for Measuring the Natural Rate of Interest," Papers 2103.16452, arXiv.org, revised Apr 2022.
    9. Pagan, Adrian & Robinson, Tim, 2022. "Excess shocks can limit the economic interpretation," European Economic Review, Elsevier, vol. 145(C).
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    Keywords

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    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • O40 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - General

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