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Ties That Bind: Estimating the Natural Rate of Interest for Small Open Economies

Author

Listed:
  • Grossman, Valerie

    (Federal Reserve Bank of Dallas)

  • Martinez-Garcia, Enrique

    () (Federal Reserve Bank of Dallas)

  • Wynne, Mark A.

    () (Federal Reserve Bank of Dallas)

  • Zhang, Ren

    () (Bowling Green State University)

Abstract

This paper estimates the natural interest rate for six small open economies (Australia, Canada, South Korea, Sweden, Switzerland and the U.K.) with a structural New Keynesian model using Bayesian techniques. Our empirical analysis establishes the following four novel findings: First, we show that the open-economy framework provides a better fit of the data than its closed-economy counterpart for the six countries we investigate. Second, we also show that, in all six countries, a monetary policy rule in which the domestic real policy rate tracks the Wicksellian domestic short-term natural rate fits the data better than an otherwise standard Taylor (1993) rule. Third, we show that over the past 35 years, the natural interest rates in all six countries have shifted downwards and strongly comoved with each other. Fourth, our findings illustrate that foreign output shocks (spillovers from the rest of the world) are a major contributor to the dynamics of the natural rate in these six small open economies, and that natural rates comove strongly with estimated U.S. natural rates.

Suggested Citation

  • Grossman, Valerie & Martinez-Garcia, Enrique & Wynne, Mark A. & Zhang, Ren, 2019. "Ties That Bind: Estimating the Natural Rate of Interest for Small Open Economies," Globalization Institute Working Papers 359, Federal Reserve Bank of Dallas, revised 31 Mar 2019.
  • Handle: RePEc:fip:feddgw:359
    DOI: 10.24149/gwp359
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    References listed on IDEAS

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    More about this item

    Keywords

    Small Open-Economy Model; Monetary Policy; Natural Rate; Bayesian Estimation;

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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