The role of the natural rate of interest in monetary policy

This paper examines the role of the natural rate of interest in the conduct of monetary policy. The natural rate figures prominently in many theories of the business cycle and of inflation fluctuations, and therefore has the potential to play a key role in monetary policy given the current mandates of many central banks. However, the presence of financial imperfections and measurement uncertainty draw into question whether estimates of the natural rate can be reliable indicators of excess demand pressures. Natural rate-based theories may, nonetheless, provide useful guidance in the formulation of desirable monetary policies.

JEL Classification Numbers: E21, E31, E32, E43, E52

Keywords: real interest rate, interest rate rules, Wicksell, New Keynesian models, financial imperfections