Ties that Bind: Estimating the Natural Rate of Interest for Small Open Economies

55 Pages Posted: 22 Apr 2019 Last revised: 29 Apr 2020

See all articles by Valerie Grossman

Valerie Grossman

Federal Reserve Banks - Federal Reserve Bank of Dallas

Enrique Martínez-García

Federal Reserve Bank of Dallas - Research Department

Mark A. Wynne

Federal Reserve Bank of Dallas

Ren Zhang

Bowling Green State University

Multiple version iconThere are 3 versions of this paper

Date Written: March, 2019

Abstract

This paper estimates the natural rate of interest for six small open economies (Australia, Canada, South Korea, Sweden, Switzerland and the U.K.) with a structural New Keynesian model using Bayesian techniques. Our empirical analysis establishes the following four main findings: First, we show that the open economy framework provides a better fit of the data than its closed economy counterpart for the six countries we investigate. Second, we also show that, in all six countries, a Taylor (1993)-type monetary policy rule that tracks the Wicksellian short-term natural rate fits the data better than a rule that does not. Third, we show that the natural interest rates of all six countries have shifted downwards and strongly comoved with each other over the past 35 years. Fourth, our findings illustrate that foreign output shocks (spillovers from the rest of the world) are a major contributor to the dynamics of the natural rate in these six small open economies and that those natural rates strongly comove also with the existing U.S. natural rate estimates.

JEL Classification: C11, C13, E43, E58, F41

Suggested Citation

Grossman, Valerie and Martinez-Garcia, Enrique and Wynne, Mark A. and Zhang, Ren, Ties that Bind: Estimating the Natural Rate of Interest for Small Open Economies (March, 2019). Globalization and Monetary Policy Institute Working Paper No. 359, Available at SSRN: https://ssrn.com/abstract=3375172 or http://dx.doi.org/10.24149/gwp359r1

Valerie Grossman (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Dallas ( email )

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Enrique Martinez-Garcia

Federal Reserve Bank of Dallas - Research Department ( email )

2200 North Pearl Street
PO Box 655906
Dallas, TX 75265-5906
United States
214-922-5262 (Phone)

HOME PAGE: http://sites.google.com/view/emgeconomics

Mark A. Wynne

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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