A General Characterization of the Capital Cost and the Natural Interest Rate: an application for Brazil

Thiago Trafane Oliveira Santos ()

No 524, Working Papers Series from Central Bank of Brazil, Research Department

Abstract: Is there a general expression for the real natural interest rate? This paper shows, based on a general characterization of the steady state capital cost, it is possible to obtain natural interest rate equations for (i) the standard or single funding rate case and (ii) the dual funding rate case. These equations become economically interpretable when more theoretical structure is added, assuming, for instance, a CES production function and a price-setting rule. This allows the use of the equations not only to estimate the natural interest rate, but also to evaluate its results. As an application, I estimate the Brazilian natural rate between 2002Q2 and 2017Q4 using the dual funding rate equation for a Cobb-Douglas production function and a semistructural macroeconomic model. The results indicate the real natural interest rate in Brazil has rapidly decreased between 2009 and 2014, from 12% p.a. to 4% p.a., mainly reflecting the lowering of the steady-state output growth rate. Given a higher potential growth, Brazil’s natural rate would be still high by international standards. Comparing to Chile, Colombia, Mexico and Peru between 2005 and 2012, the higher Brazilian rate is justified by the impact of the subsidized lending by the BNDES and, most importantly, by both the low total savings rate and the low level of firms’ markup.

Date: 2020-07
New Economics Papers: this item is included in nep-mac
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