Equilibrium rate estimates are widely used to justify easy monetary policy.
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We show that popular estimation methods deliver imprecise and unstable results.
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We provide estimates for the United States, euro area, Japan and Germany.
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Such estimates are no reliable indicators of the need for expansionary policy.
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Policy makers have used them together with inconsistent output gap estimates.
Abstract
The debate on monetary and fiscal policy is heavily influenced by estimates of the equilibrium real interest rate. In particular, this concerns estimates derived from a simple aggregate demand and Phillips curve model with time-varying components as proposed by Laubach and Williams (2003). For example, Summers (2014a) refers to these estimates as important evidence for a secular stagnation and the need for fiscal stimulus. Yellen (2015, 2017) has made use of such estimates in order to explain and justify why the Federal Reserve has held interest rates so low for so long. First, we re-estimate the United States equilibrium rate with the methodology of Laubach and Williams (2003). Then, we build on their approach and an alternative specification to provide new estimates for the United States, Germany, the euro area and Japan. Third, we subject these estimates to a battery of sensitivity tests. Due to the great uncertainty and sensitivity that accompany these equilibrium rate estimates, the observed decline in the estimates is not a reliable indicator of a need for expansionary monetary and fiscal policy. Yet, if these estimates are employed to determine the appropriate monetary policy stance, such estimates are better used together with the consistent estimate of the level of potential output.
The authors thank Thomas Laubach and John C. Williams for providing the codes used in Laubach and Williams (2003). Any remaining errors are our own. The first version of this paper was circulated in German as Beyer and Wieland (2015) under the title “Laubach-Williams type estimates of the equilibrium real interest rate for the United States, Germany and the euro area” with an English language summary in GCEE (2015).
