Measuring the Natural Interest Rate for the Turkish Economy

Vuslat Us ()

International Journal of Central Banking, 2018, vol. 14, issue 1, 259-316

Abstract: This paper measures the natural interest rate for the Turkish economy as an unobserved stochastic variable. In doing so, the study adopts a systems approach, based on a parsimonious New Keynesian model consisting of a Phillips curve, an IS curve, and a backward-looking Taylor-type interest rate rule linking the real interest rate to the natural interest rate. The model also includes stochastic laws of motion for the natural interest rate and potential output. As a contribution to the existing literature on natural interest rate and in view of the volatile nature of the Turkish economy, the parameters are assumed to be time varying. However, the requirement to simultaneously estimate parameters and to solve the statespace problem introduces non-linearity to the model. The issue of non-linearity can be handled by employing the extended Kalman filter (EKF), i.e., the use of standard Kalman filter equations to the first-order Taylor approximation of the non-linear model about the last estimate. Estimation results suggest that both the estimated natural interest rate and the real interest rate series move in tandem with the real interest rate. All the derived series are plausible and capture the significant turning points of the economy. As for the time-varying parameters, the estimated coefficients are reasonable. Overall, findings of this study provide guidance for future research on the natural interest rate, an important tool for monetary policy, and lay the basis for further work that may adopt the EKF algorithm. Most importantly, this study underlines the need to assess the stance of the monetary policy by using the natural interest rate.

Date: 2018
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Persistent link: https://EconPapers.repec.org/RePEc:ijc:ijcjou:y:2018:q:0:a:7

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