Estimating the Natural Interest Rate for the Euro Area and Luxembourg
Banque centrale du Luxembourg Working Paper No. 15
30 Pages Posted: 7 Mar 2007
Date Written: June 15, 2005
This paper estimates the natural real interest rate that is consistent with stable inflation and output at its potential for the euro area and Luxembourg. The natural interest rate provides a benchmark for assessing the monetary policy stance, as policy is contractionary when real interest rates rise above the natural rate and expansionary when real interest rates fall below this level. We follow Laubach and Williams (2003) in using a small backward-looking macroeconomic model to estimate the time-varying natural interest rate as an unobservable variable. For the euro area, our results suggest the natural interest rate has been fairly stable since 1970 and confirm its decline over the last decade. For Luxembourg, our estimate of the natural interest rate is much higher, reflecting higher potential growth. The results suggest that the single monetary policy may have an expansionary impact in recent years, especially in Luxembourg.
Keywords: Kalman filter, natural interest rate, equilibrium real interest rate
JEL Classification: C32, E43, E52
Suggested Citation: Suggested Citation