What Can the Data Tell Us About the Equilibrium Real Interest Rate?

FEDS Working Paper No. 2015-077


32 Pages Posted: 27 Sep 2015

See all articles by Michael T. Kiley

Michael T. Kiley

Board of Governors of the Federal Reserve System

Date Written: August 26, 2015


The equilibrium real interest rate (r*) is the short-term real interest rate that, in the long run, is consistent with aggregate production at potential and stable inflation. Estimation of r* faces considerable econometric and empirical challenges. On the econometric front, classical inference confronts the "pile-up" problem. Empirically, the co-movement of output, inflation, unemployment, and real interest rates is too weak to yield precise estimates of r*. These challenges are addressed by applying Bayesian methods and examining the role of several "demand shifters", including asset prices, fiscal policy, and credit conditions. We find that the data provide relatively little information on the r* data-generating process, as the posterior distribution of this process lies very close to its prior. This result contrasts sharply with those for the trend growth or natural rate of unemployment processes. Second, credit spreads are very important for the estimated links between output and interest rates and hence for estimates of r*. Estimates of r* that account for this range of considerations are more stable than other estimates, with r* at the end of 2014 equal to approximately 1-1/4 percent.

Keywords: Bayesian Methods, Equilibrium real interest rate, Potential Output

JEL Classification: E3, E4, E5

Suggested Citation

Kiley, Michael T., What Can the Data Tell Us About the Equilibrium Real Interest Rate? (August 26, 2015). http://dx.doi.org/10.17016/FEDS.2015.077. Available at SSRN: https://ssrn.com/abstract=2665710 or http://dx.doi.org/10.2139/ssrn.2665710

Michael T. Kiley (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th and C Streets, NW
Washington, DC 20551
United States
202-452-2448 (Phone)
202-452-5296 (Fax)

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