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A Time-Varying Natural Rate for the Euro Area

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  • Mésonnier, J-S.
  • Renne, J-P.

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.

Suggested Citation

  • Mésonnier, J-S. & Renne, J-P., 2004. "A Time-Varying Natural Rate for the Euro Area," Working papers 115, Banque de France.
    • Handle: RePEc:bfr:banfra:115
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    2. Mariarosaria Comunale & Jonas Striaukas, 2017. "Unconventional monetary policy: interest rates and low inflation: A review of literature and methods," CAMA Working Papers 2017-29, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.

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    More about this item

    Keywords

    Natural rate of interest ; Interest rate gap ; Monetary policy ; Kalman filter ; Output gap.;
    All these keywords.

    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
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • 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

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