Time-Varying Neutral Interest Rate—The Case of Brazil
IMF Working Papers, May 12, 2014
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Bibliographic details
- Authors: Roberto Perrelli, Shaun K. Roache
- Published: May 12, 2014
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781484385210.001
Summary
- Emerging markets have experienced a sizeable decline in their neutral real interest rates until recently.
- The paper identifies the main factors that contributed to the decline, with a focus on Brazil.
- An interval for Brazil’s time-varying neutral rate is estimated based on a range of structural and econometric models.
- The paper assesses implications of incorrectly estimating a time-varying neutral rate using a small structural model with a simple monetary policy instrument rule.
- The authors find that policy prescriptions differ markedly when facing uncertainty of the neutral rate versus uncertainty of the output gap.
- The results contrast sharply with Orphanides (2002), suggesting the best response to neutral rate uncertainty is to ensure policy remains highly sensitive to inflation and output variations.
Key findings
- Emerging markets experienced a sizeable decline in neutral real interest rates until recently.
- Policy prescriptions are very different when uncertainty concerns the neutral rate rather than the output gap.
- Best response to neutral rate uncertainty: ensure policy remains highly sensitive to inflation and output variations.
- The paper’s conclusion contrasts sharply with Orphanides (2002).
Methodology and scope
- Estimation approach: interval for Brazil’s time-varying neutral rate based on a range of structural and econometric models.
- Policy assessment: small structural model with a simple monetary policy instrument rule to evaluate implications of incorrectly estimating a time-varying neutral rate.
Policy implications and recommendations
- Monetary policy should remain highly sensitive to inflation and output variations when neutral rate is uncertain.
- Misestimation of the neutral rate can lead to markedly different policy prescriptions compared with misestimation of the output gap.
Subject and keywords
- Subject: Central bank policy rate, Financial services, Inflation, Output gap, Potential output, Prices, Production, Real interest rates
- Keywords: Central bank policy rate, equilibrium real interest rate, Global, Inflation, inflation expectation, inflation gap, inflation surprise, inflation targeting regime, inflation variability, interest rate gap, Natural rate of interest, neutral rate, Output gap, policy rate reduction, Potential output, rate uncertainty, Real interest rates, small monetary model, WP