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CNB > Economic research > Research publications > CNB Working paper series > 2018 > Quantifying the Natural Rate of Interest in a Small Open Economy – The Czech Case

Quantifying the Natural Rate of Interest in a Small Open Economy – The Czech Case

Tibor Hlédik, Jan Vlček

We identify the natural rate of interest in the Czech Republic as the real rate consistent with output at its equilibrium level and inflation at the target. To identify the rate, we use a (semi-)structural model featuring rational expectations and a forward-looking interest rate rule. Compared to the mainstream literature, the model provides a comprehensive set of cross-restrictions with respect to unobserved variables, including that of the natural rate. Furthermore, we argue that the natural rate of interest in a small open economy is a function of equilibrium real growth adjusted for equilibrium real exchange rate appreciation. Our findings suggest that the natural interest rate in the Czech Republic was around 1 percent in 2017. The current decline of the natural rate from its peak in 2015 mainly reflects the renewed appreciation of the equilibrium real exchange rate on the back of robust real GDP growth.

JEL codes: C32, E43, E52, O40

Keywords: Natural rate of interest, (semi-)structural model

Issued: July 2018

Download: CNB WP No. 7/2018 (pdf, 388 kB)