Understanding the natural rate of interest for a small open economy

Carlos Alberto Zarazúa Juárez

Latin American Journal of Central Banking (previously Monetaria), 2023, vol. 4, issue 3

Abstract: In this paper, we develop a structural model to estimate the current level of the natural rate for a small open economy, featuring a rich set of shocks to provide economic intuition for its underlying drivers. The model follows the New Keynesian tradition with several frictions and is able to draw implications for a monetary policy stance. In contrast to other DSGE models in the literature, this framework includes two main blocks—one related to the foreign sector and one associated with the local economy, linked by the uncovered interest rate parity condition. With this structure, the natural rate is affected by local and external factors, disaggregated in permanent and transitory shocks. Using Bayesian techniques, the model estimates the natural interest rate for two example cases, Mexico and Canada, considering data from these economies and the United States. Results show that the US economy is relevant to explaining natural rates in both countries. For the Mexican case, the drivers are shocks to the US risk premium and the marginal efficiency of investment, as well as country risk premium variations. For Canada, shocks to the households’ discount factor play an important role.

Keywords: Monetary policy; Central banking; Interest rates (search for similar items in EconPapers)
JEL-codes: E40 E47 E49 E52 E58 (search for similar items in EconPapers)
Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S2666143823000145
Gold Open Access

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:lajcba:v:4:y:2023:i:3:s2666143823000145

DOI: 10.1016/j.latcb.2023.100093

Access Statistics for this article

Latin American Journal of Central Banking (previously Monetaria) is currently edited by Manuel Ramos-Francia

More articles in Latin American Journal of Central Banking (previously Monetaria) from Elsevier
Bibliographic data for series maintained by Catherine Liu ().