DP6812 Money and the Natural Rate of Interest: Structural Estimates for the United States and the Euro Area

Author(s): Javier Andrés, J David López-Salido, Edward Nelson
Publication Date: May 2008
Keyword(s): money, natural rate, New Keynesian models
JEL(s): E51, E52
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=6812

We examine the role of money in three environments: the New Keynesian model with separable utility and static money demand; a nonseparable utility variant with habit formation; and a version with adjustment costs for holding real balances. The last two variants imply forward-looking behaviour of real money balances, with forecasts of future interest rates entering current portfolio decisions. We conduct a structural econometric analysis of the U.S. and euro area economies. FIML estimates confirm the forward-looking character of money demand. A consequence is that real money balances are valuable in anticipating future variations in the natural interest rate.