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Estimating the Natural Interest Rate for Iceland: An Exploratory Study

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  • Ásgeir Daníelsson
  • Ólafur Sindri Helgason
  • Stefán Thórarinsson

Abstract

We estimate the natural rate of interest for Iceland using several different methods. First we explore estimates based on the marginal productivity condition for capital, continue with various estimates based on the Euler equation for optimizing households, and end with estimates using state-space models where the natural rate is an un-observable variable, including the celebrated model by Laubach and Williams. Some of these methods give unreasonable estimates while others provide estimates that should be helpful for policy makers. The state-space models give estimates of the natural rate with negative trend before and immediately after the financial crises, but recovering during last four years of fairly rapid economic growth. The paper also provides estimates of the monetary policy stance in Iceland during the last 20 years and estimates of the implicit inflation target.

Suggested Citation

  • Ásgeir Daníelsson & Ólafur Sindri Helgason & Stefán Thórarinsson, 2016. "Estimating the Natural Interest Rate for Iceland: An Exploratory Study," Economics wp74, Department of Economics, Central bank of Iceland.
  • Handle: RePEc:ice:wpaper:wp74
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    References listed on IDEAS

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    1. Martin Seneca, 2010. "A DSGE model for Iceland," Economics wp50, Department of Economics, Central bank of Iceland.
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    6. Laubach, Thomas & Williams, John C., 2015. "Measuring the natural rate of interest redux," Working Paper Series 2015-16, Federal Reserve Bank of San Francisco.
    7. Alisdair McKay & Emi Nakamura & Jón Steinsson, 2016. "The Power of Forward Guidance Revisited," American Economic Review, American Economic Association, vol. 106(10), pages 3133-3158, October.
    8. Holston, Kathryn & Laubach, Thomas & Williams, John C., 2017. "Measuring the natural rate of interest: International trends and determinants," Journal of International Economics, Elsevier, vol. 108(S1), pages 59-75.
    9. Michael Kirker, 2008. "Does natural rate variation matter? Evidence from New Zealand," Reserve Bank of New Zealand Discussion Paper Series DP2008/17, Reserve Bank of New Zealand.
    10. Douglas Laxton & Andrew Berg & Philippe D Karam, 2006. "A Practical Model-Based Approach to Monetary Policy Analysis—Overview," IMF Working Papers 06/80, International Monetary Fund.
    11. Lubik, Thomas A. & Matthes, Christian, 2015. "Calculating the Natural Rate of Interest: A Comparison of Two Alternative Approaches," Richmond Fed Economic Brief, Federal Reserve Bank of Richmond, issue Oct, pages 1-6.
    12. Douglas Laxton & Andrew Berg & Philippe D Karam, 2006. "Practical Model-Based Monetary Policy Analysis; A How-To Guide," IMF Working Papers 06/81, International Monetary Fund.
    13. Thomas Laubach & John C. Williams, 2003. "Measuring the Natural Rate of Interest," The Review of Economics and Statistics, MIT Press, vol. 85(4), pages 1063-1070, November.
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