“Measuring the Natural Rate of Interest
Redux” by Thomas Laubach and John C.
Williams
Discussion by
Maurice Obstfeld
Economic Counsellor
International Monetary Fund
Brookings Institutions
Washington, October 30, 2015
Two key questions about natural real interest rates

How low?

How long?
2
U.S. short and long real rates
U.S. real rates
(percent)
3 month real rate
9
10 year real rate
6
3
0
Sep. 15
-3
80
82
84
86
88
90
92
94
96
98
00
02
04
06
08
10
12
14
Sources: Bloomberg, L.P., and Federal Reserve Bank of Philadelphia.
Note: Real rates are calculated based on nominal government bond yields minus SPF CPI inflation expectations.
3
Why does it matter?

Monetary policy: Perils of ZLB.

Fiscal policy: Policy space post-GFC?

Danger of debt deflation: Vicious cycle as higher
real debts (private plus public) push prices lower.

If they are indeed linked as theory says, low real
interest rates could foretell lower future growth.
4
Partial list of recent views about real interest rates
•IMF, April 2014 WEO: [R]eal interest rates will likely remain low
enough for the zero lower bound to reemerge should risks of very low
growth in advanced economies materialize.
•Hamilton et al. (August 2015): [T]he equilibrium rate may have fallen,
but not by as much as some suggest.
•Council of Economic Advisers (July 2015): A number of factors …
have contributed … with many of these factors suggesting that long-run
equilibrium interest rates have fallen.
•Pescatori and Turunen, IMF WP/15/135 (June 2015): Neutral rates
likely turned negative during the Global Financial Crisis and are
expected to increase only gradually looking forward.
•Bean et al., Geneva Report 17 (October 2015): [W]e cannot be certain
about either the magnitude or the pace of … a recovery in the neutral
real rate.
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Conclusions of Laubach-Williams redux
•[N]o evidence that the [U.S.] natural rate has moved back up even
with the economy close to fully recovered from the Great Recession.
(Note: A long-run natural rate.)
•[N]o evidence that real interest rates are typically lower five years
after a [financial] crisis …. Indeed, this time does appear to be
different…. [L]ow real rates are the new normal.
•[E]pisodes of … zero lower bound are likely to be more frequent and
longer….
•Natural-rate point estimates have recently been 0 or below, almost
half of decline ascribed to low potential GDP growth.
6
Advantages of a structural methodology

Looking at long-term averages can get you only so
far.

For example, if inflation falls sharply, output could
be below potential, and the actual real rate of
interest above the natural rate.

A structural model suggests that in these
circumstances, average market rates may over-state
the natural rate; e.g., Volcker disinflation.
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The LW approach

Unobserved (and hence estimated) values of:
1. r*
2. y*
3. g*

IS curve.

Phillips curve.

Euler/Ramsey equation linking r* and g*.

Estimated using Kalman filter.

Find ĉ = 1.3 = 1/σ = 1/0.77
8
10-year T bonds and real per capita consumption growth
6
10-year T-bond & per capita consumption growth (real)
2
4
Low frequency correlations*
1960-2007:
.48
1960-2014:
.75
-4
-2
0
*Correlation at periodicities  12 years
1960q1
60-69
70-79
80-89
90-99
2000-14
1970q1
1980q1
1990q1
time
Real per-capita
consumption growth
2.8
1.4
2.1
2.3
1.8
2000q1
2010q1
Real 10-year Tbond rate
2.8
1.5
4.4
3.3
2.2
But in the short term,
consumption growth explains
little about real interest rates.
Source: Calculations by James H. Stock,
Harvard University
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Conceptual issues: Open economy

The global capital market has become more highly
integrated.

In principle the real interest rate should depend on
global, not national, growth.

The LW framework could allow for foreign
influences on the IS or Phillips curves.

“Standard” Clarida et al. version too restrictive.

Could an extended framework give estimates of the
equilibrium current account and real exchange rate?
10
International short-term rates coherence
Global short-term real interest rates
(percent)
10
8
Interquartile range
6
4
2
GDP-weighted interest rate
0
-2
Sep.
2015
-4
90
92
94
96
98
00
02
04
06
08
10
12
14
Sources: IMF, Global Data Source; and Consensus Forecasts.
Sample includes Australia, Canada, France, Germany, Italy, Japan, Netherlands, New Zealand, Norway,
Spain, Sweden, Switzerland, United Kingdom, and United States.
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Conceptual issues: Anchoring expectations

A simplified framework would look like:

These imply:

So relatively high real rate implies deflation compared
to the anchor inflation rate.

Normally a Taylor-type rule would determine target
inflation; but what happens at ZLB?
12
Global low inflation
Headline CPI: Number of countries with low inflation rates (out of 55 countries)
Inflation rate below 2
Inflation rate below 1
Inflation rate below 0
45
45
40
40
35
35
30
30
25
25
20
20
15
15
10
10
5
5
0
0
Sep. 15
-5
07
08
09
10
11
12
13
14
-5
15
Sources: IMF, Global Data Source; and IMF staff calculations.
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A few other issues/questions

Standard errors on natural-rate estimates are large; would be
useful to see them in these updates.

Similarly for potential growth, output gap; is the point estimate for
trend growth too high, given the low estimated real rate?

Kiley (2015) suggests that additional controls in the IS equation
matter (even for the closed-economy case) and imply a higher
real-rate estimate.

Why have real rates fallen? Explanations are not disjoint:
•
•
•
Low growth expectations?
Low aggregate demand – and if so, why?
Demographics – a recent model by Carvalho, Ferrero, and Nechio
(2015) links lower population growth to lower real rates.
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Background Slides
International long-term rates coherence
Global long-term real interest rates
(quarterly, percent)
8
Interquartile range
7
6
5
4
3
2
1
GDP-weighted interest rate
0
-1
-2
2015Q3
90
92
94
96
98
00
02
04
06
08
10
12
14
Sources: IMF, Global Data Source; and Consensus Forecasts.
Sample includes Australia, Canada, France, Germany, Italy, Japan, Netherlands, New Zealand, Norway,
Spain, Sweden, Switzerland, United Kingdom, and United States.
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