An interest rate rule following the natural rate of interest for optimal monetary policy

Abstract

The natural rate of interest (NRI) plays a critical role in maintaining stable and effective monetary policy. However, its unobservable nature has led most research to focus on quantitative methods for identifying its shifts, leaving theoretical approaches relatively underexplored. This study addresses this gap by examining how a central bank can implement optimal monetary policy within the New Keynesian framework by tracking NRI fluctuations after real shocks. The analysis demonstrates that when economic agents have strong confidence in policy consistency, the central bank can accurately detect NRI shifts within two periods, regardless of the type of real shocks. This finding implies that adopting an NRI-based interest rate rule may contribute to enhancing policy effectiveness.