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Estimating the neutral real interest rate in an emerging market economy

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  • Fethi Oğunc
  • Inci Batmaz

Abstract

This study estimates the neutral real interest rate and output gap jointly under two different multivariate unobserved components models. In the analyses, Kalman filter is applied to a small-scale macroeconomic model of the Turkish economy to estimate the unobserved variables for the period 1989 to 2005. In addition, two alternative specifications for neutral real interest rate are exploited in the analyses. The first model uses a simple random walk model for the neutral rate, whereas the second one employs more structural specification, which specifically links the neutral rate with the trend growth rate and the long-term course of the risk premium by adapting the model proposed by Laubach and Williams (2003) to allow for small open economy consideration. Model evaluations clearly indicate the use of more structural specification against random walk specification. Results point out that the variation in the long-term course of the risk premium could be an important determinant of the neutral real interest rate in Turkey. Though there is relatively high uncertainty surrounding the neutral rate estimates to use them directly in the policy-making process, estimates appear to be very useful for ex post monetary policy evaluations.

Suggested Citation

  • Fethi Oğunc & Inci Batmaz, 2009. "Estimating the neutral real interest rate in an emerging market economy," Applied Economics, Taylor & Francis Journals, vol. 43(6), pages 683-693.
  • Handle: RePEc:taf:applec:v:43:y:2009:i:6:p:683-693
    DOI: 10.1080/00036840802599768
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    References listed on IDEAS

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    Cited by:

    1. Ilyas Siklar & Umit Yildiz & Sinan Cakan, 2016. "The Time - Varying Natural Rate of Interest and Its Fundamental Determinants: Time Series Evidence from Turkey," Business and Economic Research, Macrothink Institute, vol. 6(2), pages 390-400, December.
    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.

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