The natural rate of interest and the output gap in the euro area: a joint estimation

The notion of a natural real rate of interest, due to Wicksell (Interest and prices. Macmillan, London Translation of 1898 edition, 1936), is widely used in current central bank research. The idea is that there exists a level at which the real interest rate would be compatible with output at its potential level and stationary inflation. Such a concept is of primary concern for monetary policy because it provides a benchmark for the monetary policy stance. This paper applies the method suggested by Laubach and Williams (Rev Econ Stat 85(4):1063–1070, 2003) to jointly estimate the natural real interest rate and the output gap in the euro area using data from 1960 onwards. Our results suggest that the natural real rate of interest has declined gradually over the past 40 years. They also indicate that monetary policy in the euro area was on average stimulative during the 1960s and the 1970s, while it contributed to dampen the output gap and inflation in the 1980s and 1990s. The views expressed in this paper are those of the authors and do not necessarily reflect the opinions of the institutions to which they are affiliated. We are grateful to Siem Jan Koopman for very helpful suggestions and comments. We also thank P. Cour-Thimann, V. Curdia, F. Drudi, S. McCaw, D. Rodriguez-Palenzuela, R. Pilegaard, H. Pill, L. Stracca, T. Laubach, J. C. Williams and the participants of an ECB workshop on natural interest rates.