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:

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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