Inequality’s ripple effect: Analyzing its influence on the natural interest rate and monetary policy in Germany, Japan, and the US

Abstract

This paper analyzes how different forms of inequality have affected potential growth and the natural interest rate in the U.S., Germany, and Japan during the last two decades. Growing inequalities may constitute a drawback for the recovery of these economies after the Great Recession (GR) and the Covid-19 pandemic. To this aim, we modify the semi-structural model proposed by Holston, Laubach and Williams (2017) by considering the effects of several inequalities. We jointly estimate potential growth and the natural interest rates, showing that the latter can substantially modify the time path of the real interest rate, which prevails when economies are at full strength and inflation is stable. Finally, we study the effects of our estimates on the reaction functions of the monetary authorities.