Unobservable No More: Estimating the Natural Rate of Interest under Flat IS and Phillips Curves

Gabriele Fiorentini, Alessandro Galesi, Peña, Rodrigo, Pérez Quirós, Gabriel and Enrique Sentana

No 21256, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We show that the Laubach and Williams (2003) model and its variants in Holston, Laubach and Williams (2017, 2023) cannot estimate the natural rate with finite precision when either the IS curve or the Phillips curve are flat. To solve this unobservability, we propose a simple augmented model with a mean-reverting interest rate gap that considerably narrows the natural rate's confidence bands in those empirically relevant situations. We also assess the ability of the corporate risk premium and the share of working age population to explain movements in the natural rate, but they generate filtered estimates that fluctuate too much.

Keywords: Demographics; Kalman filter; Observability; Risk appetite (search for similar items in EconPapers)
JEL-codes: C32 C52 E43 E52 (search for similar items in EconPapers)
Date: 2026-03
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