Estimated Natural Rate of Interest in an Open Economy: The Case of Israel

23/07/2018 |  Elkayam David, Segal Guy
All Press Releases In Subject:
Monetary Policy and Inflation

Abstract

The new Keynesian framework as presented in Clarida et al. (2002) suggests that in an open economy, the natural rate of interest consists of a local component (the expected growth of domestic total factor productivity) and a global component (the expected growth of world output). We estimate an augmented Taylor-type rule for Israel and confirm that the above-mentioned components contain valuable information about the monetary interest rate. In particular, a large part of the decline in the monetary interest rate in 2008–2009 is explained by the exceptional decline in world growth. With regard to the other and more traditional components of the rule, we find a high and significant response of the monetary interest rate to the inflation gap, the output gap, and the real exchange rate gap.​


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