The Credit Cycle and Measurement of the Natural Rate of Interest

We set up an agent-based model that generates realistic credit cycles. Using artificial data sets, we show that fluctuations in the implicit measures of the natural rate of interest (obtained using a conventional model) may occur in the vicinity of credit cycle peaks without any underlying changes in fundamentals. The empirical analysis confirms that the measures of the natural interest rate tend to increase prior to a credit cycle peak and decrease afterwards. We conclude that the currently observed decline in the estimated natural rates of interest does not necessarily indicate changes in macroeconomic fundamentals. Instead, it may simply reflect the innate properties of the measurement technique in the vicinity of credit cycle peaks.