DP4337 Money and the Natural Rate of Interest: Structural Estimates for the UK, the US and the euro area

Author(s): Javier Andrés , J David López-Salido , Edward Nelson

Publication Date: March 2004

Keyword(s): forward-looking money demand , natural rate of interest

JEL(s): E52 , E58

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP4337.asp

In this Paper, we look at the role of money in a general framework that encompasses three competing environments: the New Keynesian model with separable utility and static money demand; the non-separable utility variant with habit formation; and the New Keynesian model modified to allow for adjustment costs for holding real balances. The last two models imply a forward-looking character of real money balances that convey on money an important role as a monetary policy indicator. We distinguish between these alternative views by conducting a structural econometric analysis for the US, the euro area, and the UK. The FIML estimates confirm the forward-looking character of the money demand. Using these estimates we find that, in response to preferences and technology shocks, money incorporates useful information regarding future variations in the natural interest rate.