Measuring the Natural Rateof Interest after COVID-19

Authors Kathryn Holston, Thomas Laubach, John C Williams
DOI https://dx.doi.org/10.2139/ssrn.4482053
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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

Implications

Notable Points

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