European Central Bank research updates euro area r* estimates and cautions against using them as a mechanical policy gauge

The European Central Bank published research in its Economic Bulletin reviewing updated estimates of the euro area natural rate of interest (r*), concluding that while r* trends can inform monetary policy and communication, the estimates are highly uncertain and cannot be used as a rule for setting policy rates. The ECB reiterates that policy decisions rely on a comprehensive assessment centred on the inflation outlook, underlying inflation dynamics and the strength of monetary policy transmission. Updated model ranges suggest the post-pandemic increase in r* has been modest and the overall range has been broadly unchanged since end-2023. For the measures that could be updated to the fourth quarter of 2024, estimates of real r* span minus 0.5% to plus 0.5%, with the corresponding nominal r* range at 1.75% to 2.25% (with conversion depending on the model). When versions of the Holston-Laubach-Williams approach are also included, the real range widens to minus 0.5% to 1% and the nominal range to 1.75% to 3%, although those HLW estimates are only available up to the third quarter of 2024. The ECB attributes the wide dispersion to model choice (including differences between slow-moving equilibrium and more cyclical inflation-stabilising concepts), parameter uncertainty, filtering uncertainty and sensitivity to data revisions, noting that revisions in model-specific point estimates can be as large as 1 percentage point and that combined parameter and filter uncertainty can span several percentage points even within a single model.