Estimating the Natural Interest Rate for Iceland: An Exploratory Study

• Main Authors: Ásgeir Daníelsson, Ólafur Sindri Helgason, Stefán Thórarinsson
• Format: Report
• Language: unknown
• Subjects: Iceland
• Online Access: http://www.cb.is/library/Skraarsafn---EN/Working-Papers/WP74%20%20net.pdf

We estimate the natural rate of interest for Iceland using several different methods. First we explore estimates based on the marginal productivity condition for capital, continue with various estimates based on the Euler equation for optimizing households, and end with estimates using state-space models where the natural rate is an un-observable variable, including the celebrated model by Laubach and Williams. Some of these methods give unreasonable estimates while others provide estimates that should be helpful for policy makers. The state-space models give estimates of the natural rate with negative trend before and immediately after the financial crises, but recovering during last four years of fairly rapid economic growth. The paper also provides estimates of the monetary policy stance in Iceland during the last 20 years and estimates of the implicit inflation target.