Working Paper

Ties That Bind: Estimating the Natural Rate of Interest for Small Open Economies

Abstract: This paper estimates the natural interest rate for six small open economies (Australia, Canada, South Korea, Sweden, Switzerland and the U.K.) with a structural New Keynesian model using Bayesian techniques. Our empirical analysis establishes the following four novel findings: First, we show that the open-economy framework provides a better fit of the data than its closed-economy counterpart for the six countries we investigate. Second, we also show that, in all six countries, a monetary policy rule in which the domestic real policy rate tracks the Wicksellian domestic short-term natural rate fits the data better than an otherwise standard Taylor (1993) rule. Third, we show that over the past 35 years, the natural interest rates in all six countries have shifted downwards and strongly comoved with each other. Fourth, our findings illustrate that foreign output shocks (spillovers from the rest of the world) are a major contributor to the dynamics of the natural rate in these six small open economies, and that natural rates comove strongly with estimated U.S. natural rates.

Keywords: small open economy model; Monetary Policy; Natural Rate; Bayesian Estimation;

JEL Classification: C11; C13; E43; E58; F41;

https://doi.org/10.24149/gwp359

Bibliographic Information

Provider: Federal Reserve Bank of Dallas

Part of Series: Globalization Institute Working Papers

Publication Date: 2019-03-31

Number: 359

Pages: 46 pages

Related Works

• Working Paper Revision: Ties That Bind: Estimating the Natural Rate of Interest for Small Open Economies