DP6812 Money and the Natural Rate of Interest: Structural Estimates for the United States and the Euro Area

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

Publication Date: May 2008

Keyword(s): money , natural rate , New Keynesian models

JEL(s): E51 , E52

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP6812.asp.asp

We examine the role of money in three environments: the New Keynesian model with separable utility and static money demand; a nonseparable utility variant with habit formation; and a version with adjustment costs for holding real balances. The last two variants imply forward-looking behaviour of real money balances, with forecasts of future interest rates entering current portfolio decisions. We conduct a structural econometric analysis of the U.S. and euro area economies. FIML estimates confirm the forward-looking character of money demand. A consequence is that real money balances are valuable in anticipating future variations in the natural interest rate.