DP13042 The Rise and Fall of the Natural Interest Rate

Author(s): Gabriele Fiorentini, Alessandro Galesi, Gabriel Pérez-Quirós, Enrique Sentana
Publication Date: July 2018
Keyword(s): demographics, Kalman filter, Natural rate of interest, observability
JEL(s): C18, C32, E43, E52
Programme Areas: International Macroeconomics and Finance
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=13042

We document a rise and fall of the natural interest rate (r*) for several advanced economies, which starts increasing in the 1960's and peaks around the end of the 1980's. We reach this conclusion after showing that the Laubach and Williams (2003) model cannot estimate r* accurately when either the IS curve or the Phillips curve is flat. In those empirically relevant situations, a local level specification for the observed interest rate can precisely estimate r*. An estimated Panel ECM suggests that the temporary demographic effect of the young baby-boomers mostly accounts for the rise and fall.