Working Paper

The Natural Rate of Interest in the Euro Area: Evidence from Inflation-Indexed Bonds

Abstract: The so-called equilibrium or natural rate of interest, widely known as r*t, is a key variable used to judge the stance of monetary policy. We offer a novel euro-area estimate based on a dynamic term structure model estimated directly on the prices of bonds with cash flows indexed to the euro-area harmonized index of consumer prices with adjustments for bond-specific risk and real term premia. Despite a recent increase, our estimate indicates that the natural rate in the euro area has fallen about 2 percentage points on net since 2002 and remains negative at the end of our sample. We also devise a related measure of the stance of monetary policy, which suggests that monetary policy in the euro area was not accommodative at the height of the COVID-19 pandemic.

Keywords: affine arbitrage-free term structure model; financial markets; frictions; monetary policy; rstar; covid19;

JEL Classification: C32; E43; E52; G12;

https://doi.org/10.24148/wp2024-08

Bibliographic Information

Provider: Federal Reserve Bank of San Francisco

Part of Series: Working Paper Series

Publication Date: 2024-03-08

Number: 2024-08