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 |
Publisher | |
Location |
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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