Measuring the Natural Rate of Interest

TLDR

The natural rate of interest, the real rate that aligns output with its natural level and keeps inflation stable, is central to macro theory but has been poorly estimated. The authors use a Kalman filter to jointly estimate time‑varying natural rates of interest and output and trend growth. They find a close link between the natural rate and trend growth, as theory predicts, yet the estimates are highly imprecise and suffer substantial real‑time measurement error.

Abstract

The natural rate of interest—the real interest rate consistent with output equaling its natural rate and stable inflation—plays a central role in macroeconomic theory and monetary policy. Estimation of the natural rate of interest, however, has received little attention. We apply the Kalman filter to estimate jointly time-varying natural rates of interest and output and trend growth. We find a close link between the natural rate of interest and the trend growth rate, as predicted by theory. Estimates of the natural rate of interest, however, are very imprecise and subject to considerable real-time measurement error.