The Natural Rate of Interest and Convergence

Martin Ertl () and Katrin Rabitsch ()
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Martin Ertl: Institute for Advanced Studies, Vienna
Katrin Rabitsch: Department of Economics, Vienna University of Economics and Business

Department of Economics Working Papers from Vienna University of Economics and Business, Department of Economics

Abstract: We explore the natural rate of interest, shortly r*, in emerging economies. If economic growth originates from convergence, then growth, say, from technological progress will be lower than we find in the data and, hence, r* will be lower. Ignoring convergence upwardly biases our estimates of r*. We extend the New Keynesian small open economy model to incorporate convergence effects and estimate it using Bayesian techniques for four emerging economies in Central and Eastern Europe: Poland, Czech Republic, Hungary and Romania. Empirical evidence of the rapid catching-up of our sample economies during the period from 2003 to 2019 assists in specifying the model estimation. Our findings confirm a decline in r* over the past decades. Accounting for capital deepening reveals meaningful differences in estimated r*, with non-negligible implications for monetary policy in emerging economies.

Keywords: natural rate of interest; convergence; New Keynesian DSGE model; Central and Eastern Europe (search for similar items in EconPapers)
JEL-codes: E3 E4 E5 (search for similar items in EconPapers)
Date: 2025-03
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