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Supply Shocks and the ‘Natural Rate of Interest': an Exploration

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  • Chadha, J.S.
  • Nolan, C.

Abstract

We develop two variants of an open economy general equilibrium model employing Blanchard-Yaari life overlapping generations, which are shown to capture a number of important aspects of the UK economic cycle. We analyse the equilibrium stochastic processes of the model’s endogenous variables in response to two primitive driving processes: total factor productivity and various measures of total factor productivity corrected for capacity utilisation over the cycle. We find, following Vickers’ (2000) suggestion, that the marginal product of capital is procyclical. Interestingly, we find that the difference between the procyclical real rate from the artificial economies and the observed real rate seems to play a role in explaining the UK inflation and output outcomes.

Suggested Citation

  • Chadha, J.S. & Nolan, C., 2001. "Supply Shocks and the ‘Natural Rate of Interest': an Exploration," Cambridge Working Papers in Economics 0103, Faculty of Economics, University of Cambridge.
  • Handle: RePEc:cam:camdae:0103
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    1. Backus, David K & Kehoe, Patrick J & Kydland, Finn E, 1994. "Dynamics of the Trade Balance and the Terms of Trade: The J-Curve?," American Economic Review, American Economic Association, vol. 84(1), pages 84-103, March.
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    5. Barro, Robert J, 1999. "Notes on Growth Accounting," Journal of Economic Growth, Springer, vol. 4(2), pages 119-137, June.
    6. Chadha, Jagjit S & Janssen, Norbert & Nolan, Charles, 2001. "Productivity and Preferences in a Small Open Economy," Manchester School, University of Manchester, vol. 69(0), pages 57-80, Supplemen.
    7. King, Robert G. & Plosser, Charles I. & Rebelo, Sergio T., 1988. "Production, growth and business cycles : II. New directions," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 309-341.
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    10. Crafts, Nicholas, 2002. "The Solow Productivity Paradox in Historical Perspective," CEPR Discussion Papers 3142, C.E.P.R. Discussion Papers.
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    12. Frenkel, Jacob A & Razin, Assaf, 1986. "Fiscal Policies in the World Economy," Journal of Political Economy, University of Chicago Press, vol. 94(3), pages 564-594, June.
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    Cited by:

    1. Mésonnier, J-S. & Renne, J-P., 2004. "A Time-Varying Natural Rate for the Euro Area," Working papers 115, Banque de France.
    2. Chadha, Jagjit S & Janssen, Norbert & Nolan, Charles, 2001. "Productivity and Preferences in a Small Open Economy," Manchester School, University of Manchester, vol. 69(0), pages 57-80, Supplemen.
    3. Michał Brzoza-Brzezina, 2002. "Estimating the Natural Rate of Interest: A SVAR Approach," NBP Working Papers 27, Narodowy Bank Polski, Economic Research Department.
    4. Mesonnier, Jean-Stephane & Renne, Jean-Paul, 2007. "A time-varying "natural" rate of interest for the euro area," European Economic Review, Elsevier, vol. 51(7), pages 1768-1784, October.
    5. Chadha, J.S. & Nolan, C., 2003. "On the Interaction of Monetary and Fiscal Policy," Cambridge Working Papers in Economics 0303, Faculty of Economics, University of Cambridge.

    More about this item

    Keywords

    natural rate; productivity shocks; real rates;

    JEL classification:

    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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