DP11927 Instability, imprecision and inconsistent use of equilibrium real interest rate estimates

Author(s): Robert Beyer, Volker Wieland
Publication Date: March 2017
Keyword(s): equlibrium real interest rate, estimation, monetary policy
JEL(s): E40, E43, E52
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=11927

The current debate on monetary and fiscal policy is heavily influenced by estimates of the equilibrium real interest rate. In particular, this concerns estimates derived from a simple aggregate demand and Phillips curve model with time-varying components as proposed by Laubach and Williams (2003). For example, Summers (2014a) refers to these estimates as important evidence for a secular stagnation and the need for fiscal stimulus. Yellen (2015, 2017) has made use of such estimates in order to explain and justify why the Federal Reserve has held interest rates so low for so long. First, we re-estimate the U.S. equilibrium rate with the methodology of Laubach and Williams (2003). Then, we build on their approach and the modifications proposed in M├ęsonnier and Renne (2007) and Garnier and Wilhelmsen (2009) to provide new estimates for the United States, the euro area and Germany. Third, we subject these estimates to a battery of sensitivity tests. Due to the great uncertainty and sensitivity that accompany these equilibrium rate estimates, the observed decline in the estimates is not a reliable indicator of a need for expansionary monetary and fiscal policy. Yet, if these estimates are employed to determine the appropriate monetary policy stance, such estimates are better used together with the consistent estimate of the level of potential output.