Working Paper
Money as Indicator for the Natural Rate of Interest
The natural interest rate is of great relevance to central banks, but it is difficult to measure. We show that in a standard microfounded monetary model, the natural interest rate comoves with a transformation of the money demand that can be computed from actual data.
The co-movement is of a considerable magnitude and independent of monetary policy. An
optimizing central bank that does not observe the natural interest rate can take advantage
of this co-movement by incorporating the transformed money demand, in addition to the
observed output gap and inflation, into a simple but optimal interest rate rule. Combining
the transformed money demand and the observed output gap provides the best information
about the natural interest rate.
Key Words
- money demand
- Natural interest rate
- optimal monetary rule