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Estimating the Natural Rate of Interest in an Open Economy

Mark Wynne () and Ren Zhang ()

No 316, Globalization Institute Working Papers from Federal Reserve Bank of Dallas

Abstract: The concept of the natural or equilibrium rate of interest has attracted a lot of attention from monetary policymakers in recent years. Most attempts to estimate the natural rate use a closed economy framework. We argue that in the face of greater integration of global product and capital markets, an open economy framework is more appropriate. We provide some initial estimates of the natural rate for the United States and Japan in a two-country framework. Our identifying assumptions include a close relationship between the time-varying natural rate of interest and the low-frequency fluctuations of potential output growth in both the home country and the foreign country. Our results suggest that the natural rates in both countries are mainly determined by their own trend growth rates of potential output. Nevertheless, the other country's trend growth plays an important role in several specific periods. The gap between the actual real interest rate and our estimated natural rate offers valuable insights into the recent stance of monetary policy in both of these two countries.

JEL-codes: C32 E32 E4 E52 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac, nep-mon and nep-opm
Date: 2017-06-20
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Journal Article: Estimating the natural rate of interest in an open economy (2018) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:fip:feddgw:316

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DOI: 10.24149/gwp316

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