June 2020 issue contents
What Can the Data Tell Us about the Equilibrium Real Interest Rate?

Michael T. Kiley
Federal Reserve Board


The equilibrium real interest rate (r∗) is the short-term real interest rate that, in the long run, is consistent with aggregate production at potential and stable inflation. Estimation of r∗ faces considerable econometric and empirical challenges, including the "pile-up" problem in which maximum-likelihood estimation may underestimate the time variation in r∗. In light of these challenges, this analysis considers Bayesian methods and examines the degree to which a researcher's prior views, rather than the data, shapes inference on the r∗ process. I find that the data provide relatively little information on the r∗ data-generating process, as the posterior distribution of this process lies very close to its prior. This result contrasts sharply with those for the trend growth or natural rate of unemployment processes. Conditional on a prior view that the r∗ process involves only small quarter-to-quarter changes in r∗, estimates of r∗ show a gradual decline to a value below 1 percent in recent years. Auxiliary properties of the model, such as its output gap, are in line with consensus views.

JEL Code: E5, E3, E4.

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