Market-Based Estimates of the Natural Real Rate: Evidence from Latin American Bond Markets

Abstract

We provide market-based estimates of the natural real rate, that is, the steady-state short-term real interest rate, for Brazil, Chile, and Mexico. Our approach uses a dynamic term structure finance model estimated directly on the prices of individual inflation indexed bonds with adjustments for bond-specific liquidity and real term premia. First, we find that inflation-indexed bond liquidity premia in all three countries are sizable with significant variation. Second, we find large differences in their estimated equilibrium real rates: Brazil’s is large and volatile, Mexico’s is stable but elevated, while Chile’s is low and has fallen persistently. Although uncertain, our estimates could have important implications for the conduct of monetary policy in these three countries.