Measuring the Natural Interest Rate in a Small Open Economy

This paper presents a model for estimating the natural interest rate in a small open economy adapting the Laubach and Williams (2003) and Holston et al. (2017) closed economy model. The natural interest rate is determined from the uncovered interest rate parity instead of the trend growth of potential output. The model is applied to the Brazilian economy in the period 2004Q1-2019-Q4 and estimated using the Bayesian method. The results show a strongly oscillating natural rate of interest since the 2014 Brazilian great recession. Compared with the closed economy framework, the small open economy approach shows greater ability to explain the origins of the natural rate’s fluctuations over the period analyzed