Estimating the Natural Rate of Interest in an Open Economy

39 Pages Posted: 21 Jun 2017

See all articles by Mark A. Wynne

Mark A. Wynne

Federal Reserve Bank of Dallas

Ren Zhang

Bowling Green State University

Date Written: 2017-06-20

Abstract

The concept of the natural or equilibrium rate of interest has attracted a lot of attention from monetary policymakers in recent years. Most attempts to estimate the natural rate use a closed economy framework. We argue that in the face of greater integration of global product and capital markets, an open economy framework is more appropriate. We provide some initial estimates of the natural rate for the United States and Japan in a two-country framework. Our identifying assumptions include a close relationship between the time-varying natural rate of interest and the low-frequency fluctuations of potential output growth in both the home country and the foreign country. Our results suggest that the natural rates in both countries are mainly determined by their own trend growth rates of potential output. Nevertheless, the other country's trend growth plays an important role in several specific periods. The gap between the actual real interest rate and our estimated natural rate offers valuable insights into the recent stance of monetary policy in both of these two countries.

JEL Classification: C32, E32, E4, E52

Suggested Citation

Wynne, Mark A. and Zhang, Ren, Estimating the Natural Rate of Interest in an Open Economy (2017-06-20). Globalization and Monetary Policy Institute Working Paper No. 316, Available at SSRN: https://ssrn.com/abstract=2990309 or http://dx.doi.org/10.24149/gwp316

Mark A. Wynne (Contact Author)

Federal Reserve Bank of Dallas ( email )

PO Box 655906
Dallas, TX 75265-5906
United States
214-922-5159 (Phone)
214-922-5194 (Fax)

Ren Zhang

Bowling Green State University ( email )

Department of Psychology
Bowling Green, OH 43403
United States

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