(Un)Naturally Low? Sequential Monte Carlo Tracking of the US Natural Interest Rate

Abstract

Following the 2000 stockmarket crash, have US interest rates been held too low in relation to their natural level? Most likely, yes. Using a structural model, this paper attempts a real-time assessment of the US monetary policy while ensuring consistency between the specification of price adjustments and the evolution of the economy under flexible prices. To do this, the model's likelihood function is evaluated using particle filtering, allowing for sequential inference about the time-varying distribution of structural parameters and unobservable, nonstationary state variables. Accounting for real-time expectations and time variation in underlying equilibrium levels is found crucial (i) to explain postwar Fed's policy and (ii) to replicate salient features of the data.