Neutral Real Interest Rate, Monetary Policy and Business Cycle: Using the Kalman Filter and a Counterfactual Structural Approach for a Large Emerging Market

Ricardo Ramalhete Moreira

International Journal of Economics and Finance, 2024, vol. 16, issue 12, 62

Abstract: Central banks monitor the evolution of economic aggregates in order to enhance the effectiveness of monetary policy, within the context of inflation targeting regimes. This paper assesses whether controlling or not the path of the neutral real interest rate alters business cycle responses to structural shocks in monetary policy. For this purpose, the study uses the Kalman filter to extract the latent variable of neutral interest rates, as well as a counterfactual exercise based on parsimonious SVAR models, both applied to Brazil. The evidence suggests that omitting the trajectory of the neutral real rate introduces biases in the estimated stochastic responses of economic activity to unanticipated changes in monetary policy. Quantitatively, this omission results in a loss of approximately 5% of the estimated marginal effects in the first 12 months, in addition to bringing forward the initial impacts by 6 months, and a loss of up to 70% in the estimated effects over a 24-month horizon. Such results were robust for the inclusion of the US long term real interest rate and the country risk perception.

Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:ibn:ijefaa:v:16:y:2024:i:12:p:62

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