Lower for Longer: Neutral Rates in the United States
IMF Working Papers, June 24, 2015
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Bibliographic details
- Authors: Andrea Pescatori, Jarkko Turunen
- Published: June 24, 2015
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781513508382.001
Summary
- Study uses a semi structural model to estimate neutral rates in the United States.
- Bayesian estimation incorporates prior information on the output gap and potential output (based on a production function approach).
- Unconventional monetary policies at the ZLB are accounted for using estimates of “shadow” policy rates.
- The approach provides more plausible results than standard maximum likelihood estimates for the unobserved variables in the model.
- Results show a significant trend decline in the neutral real rate over time, driven only in part by a decline in potential growth; other factors (including excess global savings) matter.
- Neutral rates likely turned negative during the Global Financial Crisis and are expected to increase only gradually looking forward.
Methodology
- Semi structural model framework.
- Bayesian estimation that:
- Incorporates prior information on the output gap.
- Incorporates prior information on potential output based on a production function approach.
- Adjustment for zero lower bound (ZLB) monetary policy by using “shadow” policy rate estimates.
- Comparison with standard maximum likelihood estimation for unobserved variables.
Key Findings
- Significant trend decline in the neutral real rate over time.
- Decline in potential growth explains only part of the decline in the neutral real rate.
- Other factors, including excess global savings, contribute to the decline.
- Neutral rates likely turned negative during the Global Financial Crisis.
- Neutral rates are expected to increase only gradually going forward.
Policy-Relevant Implications
- Conventional estimates that ignore shadow rates and prior information on potential output may misstate unobserved variables such as the neutral real rate and output gap.
- Accounting for unconventional monetary policy at the ZLB (via shadow rates) yields more plausible dynamics for neutral rates and policy stance.
- Persistent low neutral rates imply a constrained buffer for conventional monetary policy normalization and highlight the importance of macroprudential, fiscal, and structural policies to support demand and potential growth.