A Time-Varying Natural Rate for the Euro Area

44 Pages Posted: 11 Nov 2010

See all articles by Jean-Stéphane Mésonnier

Jean-Stéphane Mésonnier

affiliation not provided to SSRN

Jean-Paul Renne

University of Lausanne - School of Economics and Business Administration (HEC-Lausanne)

Date Written: September 1, 2004

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.

Keywords: Natural rate of interest, interest rate gap, monetary policy, Kalman filter, output gap

JEL Classification: C32, E32, E43, E52

Suggested Citation

Mésonnier, Jean-Stéphane and Renne, Jean-Paul, A Time-Varying Natural Rate for the Euro Area (September 1, 2004). Banque de France Working Paper No. 115, Available at SSRN: https://ssrn.com/abstract=1706148 or http://dx.doi.org/10.2139/ssrn.1706148

Jean-Stéphane Mésonnier (Contact Author)

affiliation not provided to SSRN ( email )

Jean-Paul Renne

University of Lausanne - School of Economics and Business Administration (HEC-Lausanne) ( email )

UNIL, Batiment Internef
Lausanne, 1015
Switzerland

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