International comovement of r∗: A case study of the G7 countries

The natural rate of interest, r∗, is an important input to determine the appropriate monetary policy stance. Commonly, the measurement is estimated on a single-country basis, which ignores the international factors that may affect r∗. However, expanding to a multiple-country model adds substantive model complexity. In this paper, I exploit a Bayesian method to build a multi-country state space model, which is an extension of Holston et al. (2017), to jointly estimate r∗ for the G7 countries. Furthermore, in the process of estimating the model, I decompose the country level r∗ into common, regional, and idiosyncratic components and identify the dynamics of each component. I find that across the G7 countries r∗ has been declining since the 1990s and is driven by the common component. I also find the contribution of the idiosyncratic components to r∗ is minor. These results suggest a synchronization of the natural rate of interest across countries since the 1990s, supporting the idea posited in Del Negro et al. (2019) that the low natural rate is due to a rise in the demand for safe and liquid assets.