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Monetary policy and the natural rate of interest

In: Threat of fiscal dominance?

Author

Listed:
  • Matthew Canzoneri

    (Georgetown University)

  • Robert Cumby

    (Georgetown University)

  • Behzad Diba

    (Georgetown University)

Abstract

It is most important for monetary policy to track the natural rate of interest when interest rates take large and sustained swings away from their long‐run equilibrium values. Here, we study two models: a standard New Keynesian model and one in which government bonds provide liquidity. Policy rules that cannot track the natural rate perform poorly in both models, but are especially bad in the second because of sustained movements in the natural rate induced by fiscal shocks. First difference rules, on the other hand, do surprisingly well. When model uncertainty is taken into account, the dominance of the first difference rule is even more pronounced.
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Suggested Citation

  • Matthew Canzoneri & Robert Cumby & Behzad Diba, 2012. "Monetary policy and the natural rate of interest," BIS Papers chapters,in: Bank for International Settlements (ed.), Threat of fiscal dominance?, volume 65, pages 119-134 Bank for International Settlements.
  • Handle: RePEc:bis:bisbpc:65-07
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    File URL: http://www.bis.org/publ/bppdf/bispap65g_rh.pdf
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    References listed on IDEAS

    as
    1. Ludger Linnemann & Andreas Schabert, 2010. "Debt Nonneutrality, Policy Interactions, And Macroeconomic Stability," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 51(2), pages 461-474, May.
    2. Andrea Tambalotti & Andrea Ferrero & Vasco Curdia, 2010. "Evaluating Interest Rate Rules in an Estimated DSGE Model," 2010 Meeting Papers 402, Society for Economic Dynamics.
    3. Matthew Canzoneri & Robert Cumby & Behzad Diba & David Lãpez-Salido, 2008. "Monetary Aggregates and Liquidity in a Neo-Wicksellian Framework," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(8), pages 1667-1698, December.
    4. Carolin E. Pflueger & Luis M. Viceira, 2011. "Return Predictability in the Treasury Market: Real Rates, Inflation, and Liquidity," Harvard Business School Working Papers 11-094, Harvard Business School, revised Sep 2013.
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    Cited by:

    1. Solikin M Juhro, 2016. "Comments on "A spectral perspective on natural interest rates in Asia-Pacific: changes and possible drivers"," BIS Papers chapters,in: Bank for International Settlements (ed.), Expanding the boundaries of monetary policy in Asia and the Pacific, volume 88, pages 151-156 Bank for International Settlements.
    2. Feng Zhu, 2016. "A spectral perspective on natural interest rates in Asia-Pacific: changes and possible drivers," BIS Papers chapters,in: Bank for International Settlements (ed.), Expanding the boundaries of monetary policy in Asia and the Pacific, volume 88, pages 63-149 Bank for International Settlements.

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