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