Estimating the Natural Real Interest Rate in Lithuania: A Semi-Structural Approach

Zymantas Budrys and Giedre Krotovaite
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Zymantas Budrys: Lietuvos bankas, Vilnius University
Giedre Krotovaite: Lietuvos bankas, Vilnius University

No 59, Bank of Lithuania Occasional Paper Series from Bank of Lithuania

Abstract: This paper estimates the natural real interest rate (r*) for Lithuania over the period 2000–2025 and assesses the implied monetary policy conditions. The paper employs a semi-structural unobserved-components model tailored to a small, open, and converging economy by incorporating real effective exchange rate dynamics, while also enhancing output-gap identification and exploring the role of survey-based inflation expectations. The results indicate that Lithuania’s r* was relatively high in the early 2000s, declined markedly during the global financial crisis, remained persistently low thereafter, and returned to positive values in recent years. Following the euro’s adoption, Lithuania’s estimated r* exhibits closer co-movement with the euro area’s natural rate, consistent with deeper economic and financial integration. Estimates of the real interest rate gap suggest that monetary conditions have been predominantly accommodative historically and broadly neutral in recent periods. Classification-E43, E52, C11, C32, F41

Keywords: Natural interest rate; r-star; unobserved components; Lithuania; small open economy; interest rate gap (search for similar items in EconPapers)
Pages: 31 pages
Date: 2026-01-23
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