The output gap and the real interest rate gap in the euro area, 1960–2003

In this paper we aim at identifying the natural real rate of interest, defined here as the (unobservable) component of the real interest rate which has no contemporaneous and lagged correlation with the output gap. We first discuss the theoretical underpinnings and the possible empirical advantages of this measure. Based on this definition and taking a measure of the output gap as given, we then derive an estimate of the natural interest rate for the euro area over a sample period from 1960 to 2003. The corresponding estimate of the natural interest rate measure is found to fluctuate significantly, a finding which appears to be well explained by economic and institutional developments in the euro area over the past 4 decades. Moreover, the resulting estimate of the real rate gap is found to have some forward-looking information content on inflationary pressure in the euro area.