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Federal Reserve Bank of Dallas
Globalization Institute Working Papers
Ties That Bind: Estimating the Natural Rate of Interest for Small Open Economies
Valerie Grossman
Enrique Martinez-Garcia
Mark A. Wynne
Ren Zhang
Abstract

This paper estimates the natural interest rate for six small open economies (Australia, Canada, South Korea, Sweden, Switzerland and the U.K.) with a structural New Keynesian model using Bayesian techniques. Our empirical analysis establishes the following four novel findings: First, we show that the open-economy framework provides a better fit of the data than its closed-economy counterpart for the six countries we investigate. Second, we also show that, in all six countries, a monetary policy rule in which the domestic real policy rate tracks the Wicksellian domestic short-term natural rate fits the data better than an otherwise standard Taylor (1993) rule. Third, we show that over the past 35 years, the natural interest rates in all six countries have shifted downwards and strongly comoved with each other. Fourth, our findings illustrate that foreign output shocks (spillovers from the rest of the world) are a major contributor to the dynamics of the natural rate in these six small open economies, and that natural rates comove strongly with estimated U.S. natural rates.


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Valerie Grossman & Enrique Martinez-Garcia & Mark A. Wynne & Ren Zhang, Ties That Bind: Estimating the Natural Rate of Interest for Small Open Economies, Federal Reserve Bank of Dallas, Globalization Institute Working Papers 359, 31 Mar 2019, revised 31 Mar 2019.
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Keywords: Small Open-Economy Model; Monetary Policy; Natural Rate; Bayesian Estimation
DOI: 10.24149/gwp359
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