Last week the National Bank of Ukraine (NBU) hosted a regular open research seminar in which the NBU academics, leading Ukrainian economists, experts and young researchers participated.
The seminar speaker was Serhiy Nikolaichuk, Head of the Monetary Policy and Economic Analysis Department at the NBU. He presented the findings of a study entitled Equilibrium Real Interest Rate in the Case of Small Open Economy: Application for Ukraine. The research was conducted in collaboration with Volodymyr Lepushynskyi, Head of the Monetary Policy Office, and Anton Grui, Chief Economist of the Modeling Division.
In their study, the authors analyzed real equilibrium (neutral) interest rate, which is the interest rate that would be chosen if the economy were at its equilibrium, that is, with inflation being on target and GDP and the employment rate at their potential level.
The key policy rate has become the main monetary policy instrument in the conditions of inflation targeting regime pursued by the NBU. At the same time, measuring real equilibrium interest rate plays an important role for the analysis of monetary conditions. If the real key policy rate is higher or lower than real neutral rate, the central bank is said to conduct tight or loose monetary policy. The equilibrium interest rate is also essential for monetary policy in the sense that it is one of the variables in the Taylor Rule.
The topic on measuring real equilibrium interest rate provoked wide interest of researchers, with a strong emphasis on developed economies, where low interest rates failed to provide the necessary impetus. The researchers pointed to the fact that interest rates there had fallen significantly, even to negative levels. In their study, the authors expanded the boundaries of existing researches by analyzing equilibrium interest rate in a small open economy.
Serhii Nikolaichuk noted that real equilibrium interest rate can be determined by the interaction of supply and demand for funds. The case of a small open economy is distinct due to the fact that the supply of savings is determined by global markets. In other words, there is a strong dependence on external conditions. At this, key internal factors are a sovereign risk premium and anticipated changes in the real exchange rate. The study in question focuses on forecasting such factors in the mid-term.
The authors have developed their own methodology pertaining to the equation of uncovered interest rate parity, and all the calculations have been made using the NBU Quarterly Projection Model. In the presented study, estimates were made of historical time series for Ukraine’s economy from 2005. “During this period, real equilibrium rate was rather volatile, but in recent years it has been gradually decreasing against the backdrop of the falling premium for sovereign risk and the tendency towards strengthening real exchange rate. It is expected to reach the level of 1% per annum in the mid-term,” said Mr Nikolaichuk.
He also underscored that, historically, monetary policy implemented by the NBU was loose in view of the fixed exchange rate and fiscal dominance. Accordingly, real interest rates were lower than the equilibrium one. Instead, over the past two years, monetary policy pursued by the NBU has been rather tight, creating the necessary conditions for curbing inflation and improving inflation expectations.
The video of the seminar is available at the following link.
We encourage potential contributors to participate in the upcoming seminars and present the findings of their research studies. To this end, please send your submissions (CV, a presentation and/or article specifying a suitable date for the seminar to take place). Please send your proposals to the Research Division of the Monetary Policy and Economic Analysis Department for consideration via e-mail: [email protected]