https://doi.org/10.52903/wp2026366
THE ECONOMETRICS OF THE EURO-AREA NATURAL RATE OF INTERESTnbsp;
Dimitrios P. Louzis
Bank of Greece
ABSTRACT
The natural rate of interest (r*) plays a central role in monetary policy analysis, but its estimation is inherently model dependent. This paper studies how alternative econometric specifications affect the estimates of r* in the euro-area. We propose a Hybrid Common Trend Vector Autoregression that incorporates a large information set, stochastic volatility, and fat-tailed innovations. Using euro-area data spanning the last 25 years, we find that these features materially improve inference, reducing the width of 95\% credible intervals for r* by as much as 100 basis points relative to conventional specifications. Our results point to a persistent decline in the natural rate between 2000 and 2020, followed by a moderate post-pandemic recovery. The decomposition of r* identifies the trend of labor productivity growth as the dominant driver of its long-run movements. The findings suggest that uncertainty surrounding r* is partly econometric in nature and can be reduced through richer empirical specifications.
Keywords: Real interest rates, labor productivity growth trend, large Bayesian vector autoregressions, stochastic volatility, fat tails.
JEL-classifications: E43; E52; C11; C32;
Disclaimer: The views expressed in this paper are those of the author and do not necessarily reflect the views of the Bank of Greece. Any remaining errors are the sole responsibility of the author.
Correspondence:
Dimitrios P. Louzis
Economic Analysis and Research Department
Bank of Greece
El. Venizelos 21, 10250 Athens, Greece
Tel.: +30-2103202648
email: dlouzis@bankofgreece.gr