The Hidden Natural Interest Rate

Article DOI: doi.org/10.66293/aayam.v16.i1.01

AUTHOR
Gonzalo Perez-Seoane *

KEYWORDS
Natural interest rate, Nominal neutral interest rate, Monetary policy, Fisher effect, Fisher's open hypothesis, World Monetary Optimum, Economic growth.

ABSTRACT
According to the most common definition, the natural interest rate is the real interest rate that leads the economy to full employment with stable inflation. It is, therefore, the most important interest rate in the economy, although, to date, it remains merely a theoretical rate. Central banks set their short-term monetary policy primarily through interest rate policy, which is reflected in the change over time in the nominal neutral interest rate. To this end, it is particularly useful to estimate the supposed natural interest rate. The approaches proposed in monetary theory to determine the natural interest rate are diverse, although to date the natural interest rate remains an unobserved variable. Is it possible to verify its value objectively? This paper puts forward a new hypothesis to empirically identify and verify the natural interest rate with Fisher’s (extended) theory on the nature of interest rates serving as the starting point. In other words, identifying the natural interest rate requires decoding Fisher’s two famous hypotheses: the “Fisher's open hypothesis” and the“Fisher effect”. Finally, once the natural interest rate has been objectively identified, a surprising conclusion emerges that has not been considered in economic thought: there is a world and national optimum for the natural interest rate and, consequently, for monetary policy at a global level. The empirical evidence found shows that countries with a higher, positive natural interest rate tend to converge towards the world monetary optimum and experience higher relative growth, and vice versa