Measuring the Natural Rate of Interest

27 Pages Posted: 17 Dec 2001

See all articles by Thomas Laubach

Thomas Laubach

Board of Governors of the Federal Reserve System

John C. Williams

Federal Reserve Bank of New York

Date Written: 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 depends on the trend growth rate of output. In this paper we apply the Kalman filter to jointly estimate the natural rate of interest, potential output, and the trend growth rate, and examine the empirical relationship between these estimated unobserved series. We find substantial variation in the natural rate of interest over the past four decades in the United States. Our natural rate estimates vary about one-for-one with changes in the trend growth rate. We show that policymakers' mismeasurement of the natural rate of interest can cause a significant deterioration in macroeconomic stabilization.

Keywords: Natural rate of interest, interest rate rules, Kalman filter, trend growth, potential output

JEL Classification: C32, E43, E52, O40

Suggested Citation

Laubach, Thomas and Williams, John C., Measuring the Natural Rate of Interest (November 2001). Available at SSRN: https://ssrn.com/abstract=293951 or http://dx.doi.org/10.2139/ssrn.293951

Thomas Laubach (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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Washington, DC 20551
United States
202-452-2715 (Phone)
202-452-3819 (Fax)

John C. Williams

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

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