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

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.

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Citation

Andrés, J, J López-Salido and E Nelson (2008), ‘DP6812 Money and the Natural Rate of Interest: Structural Estimates for the United States and the Euro Area‘, CEPR Discussion Paper No. 6812. CEPR Press, Paris & London. https://cepr.org/publications/dp6812