Measuring the Natural Rateof Interest after COVID-19
Background and Objective
- The paper addresses the challenge of estimating the natural rate of interest following the COVID-19 pandemic.
- It builds on and modifies existing models (Holston-Laubach-Williams and Laubach-Williams) to account for the unprecedented economic volatility during the pandemic period.
Methodology
The authors make two key modifications to the existing models:
- 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.
- 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
- 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.
- 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.
- 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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