Background and Objective

Methodology

The authors make two key modifications to the existing models:

  1. Introduction of time-varying volatility:
    • Applies scale factors to innovation variances during 2020-2022.
    • Allows for higher volatility in economic shocks during the pandemic period.
  2. Incorporation of a persistent COVID supply shock:
    • Uses the Oxford COVID-19 Stringency Index as a proxy for pandemic effects.
    • Adjusts the natural rate of output based on this COVID indicator.

Key Findings

  1. Natural rate of interest:
    • Estimates for the US, Canada, and Euro Area in 2022 are close to pre-pandemic levels.
    • No evidence of a reversal in the trend of historically low natural interest rates.
  2. Natural rate of output:
    • Estimates have declined relative to pre-pandemic projections.
    • This represents the most significant lasting economic effect of the COVID-19 pandemic according to the model.
  3. Trend growth:
    • Estimates are slightly lower in 2022 compared to 2019.
    • Continues the pattern of declining trend growth observed over previous decades.

Robustness and Extensions

  • The findings are robust to alternative specifications of time-varying volatility and output measures.
  • The approach is applied to both the HLW and LW models with similar results.

Implications

  • The paper provides a framework for estimating latent economic variables during periods of extreme volatility.
  • It suggests that while the pandemic had significant short-term impacts, it did not fundamentally alter the long-term trajectory of natural interest rates.

Notable Points

  • The paper’s approach allows for continued estimation of natural rates through the pandemic period, rather than simply discarding this data.
  • The modifications to the model effectively address the econometric issues caused by the pandemic’s extreme economic effects.
  • The findings challenge some commentary suggesting that fiscal stimulus and rising government debt during the pandemic would lead to higher natural interest rates.

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