Measuring the Natural Rate of Interest
Thomas LaubachJohn C. WilliamsBoard of Governors of the Federal Reserve System
∗
November 2001
Abstract
A key variable for the conduct of monetary policy is the natural rate of interest– the real interest rate consistent with output equaling potential and stable inflation.Economic theory implies that the natural rate of interest varies over time and dependson the trend growth rate of output. In this paper we apply the Kalman filter to jointlyestimate the natural rate of interest, potential output, and its trend growth rate, andexamine the empirical relationship between these estimated unobserved series. We findsubstantial variation in the natural rate of interest over the past four decades in theUnited States. Our natural rate estimates vary about one-for-one with changes in thetrend growth rate. We show that policymakers’ mismeasurement of the natural rate of interest can cause a significant deterioration in macroeconomic stabilization.
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