Abstract
This paper estimates the term structure of natural interest rates for Brazil, a generalization of the concept of natural rate of interest for the yield curve. First, the Diebold-Li (2006) model is estimated with real yields. The latent factors of this model are then used in a model that includes an IS and a Phillips curve. The natural yield curve is obtained as the level, slope and curvature that closes the output gap at each point in time. This decomposition allows a broader indicator of the stance of monetary policy and a real-time measure of the natural rate. The difference between the slope of the real curve and its natural counterpart is highly correlated with the output gap.
Highlights
This paper estimates the natural yield curve for Brazil
The real yield curve is estimated based on three latent factors using the dynamic Nelson-Siegel (DNS) model, and these factors are used as observables in the natural yield curve model, based on the Laubach & Williams (2003) model, comprising an IS and a Phillips curve
This paper estimated the natural yield curve for Brazil, a concept introduced by Brzoza-Brzezina & Kotłowski (2014) and Imakubo et al (2018) that extends the concept of natural rate to the yield curve
Summary
This paper estimates the natural yield curve for Brazil. The natural (equivalently: r-star, neutral or equilibrium) real rate (Wicksell, 1936) is defined as the interest rate that is consistent with price stability and potential output. With the lower bound on nominal rates, the gap between short-term real rates and the natural rate became a less reliable indicator of the stance of monetary policy (Brzoza-Brzezina & Kotłowski, 2014; Imakubo et al, 2018), with the focus shifting from short rates to the whole yield curve Another attempt to incorporate financial conditions in measures of the natural rate is given by Hakkio & Smith (2017), who allow credit and term premiums to affect the evolution of the natural rate in the Laubach and Williams model.
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