Estimating the Indian natural interest rate: A semi-structural approach

Ashima Goyal and Sanchit Arora

Economic Modelling, 2016, vol. 58, issue C, 141-153

Abstract: We estimate unobserved Indian time-varying natural interest rate (NIR), potential output, and trend growth using the Kalman filter. Semi-structural New Keynesian estimates of aggregate demand and supply with adaptive expectations provide inputs in the process. Sensitivity analysis confirms the Indian aggregate demand to be elastic and aggregate supply flat but subject to frequent shocks. The NIR is extracted from a model where optimization seeks to maintain subsistence consumption. Food price shocks reduce subsistence consumption and raise the willingness to work to protect it, reducing the NIR, but to the extent they raise inflation NIR rises. This dual role reflects transition in an economy that has a high growth potential if it can overcome structural bottlenecks. Since food price shocks are volatile, they raise the estimated volatility of all three unobserved variables, but improve precision of NIR estimation, better capture turning points that require a changed policy stance, and explain volatility of trend growth in emerging markets. Monetary policy was broadly contractionary and procyclical for the period under study. Using food inflation and its impact on NIR could improve policy decisions.

Keywords: Natural interest rate; Potential output; Trend growth rate; Kalman filter; Monetary policy (search for similar items in EconPapers)
JEL-codes: E32 E43 E52 (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (15)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:58:y:2016:i:c:p:141-153

DOI: 10.1016/j.econmod.2016.05.023

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