The paper estimates a closed-economy medium-scale model for the United States and the euro area to assess the current level of the natural rate of interest and shed light on its drivers. The dynamics of the model are driven by permanent and transitory shocks that bear some connection to the explanations put forward in the literature to explain the secular downward trend in interest rates. The analysis shows that the natural rate has declined, contributing to a lowering of nominal and real rates. Risk premium shocks, a short-cut for changes in agents’ preference for safe assets, have been an important driver in the euro area; in the United States, shocks to the risk premium and to the efficiency of investment, which proxy the functioning of the financial sector, have played a major role. These differences in the importance of the shocks underscore the need to adopt a structural model with a rich stochastic structure, featuring permanent and transitory shocks.
Published in 2019 in: Journal of Macroeconomics, v. 62, article 103019.