Co-authors: Dora Xia and Hongyi Chen
Evaluating the stance of monetary policy for the open economies of East Asia requires a different approach than that developed for the US. In recent years, the discussion has centered around the concept of the neutral real interest rate, or r*. A commonly used definition of r* is the interest rate that prevails when economic slack is zero and inflation is stable. Observers then ask, by comparing r* with the existing policy rate, whether current monetary conditions are too accommodative or too restrictive.
The neutral rate of interest is inherently unobservable as it is a hypothetical concept. Consequently, it must be inferred through estimation. The semi-structural models designed to estimate r* for the US do not adequately capture the macroeconomic dynamics of East Asian economies. In particular, exchange rates and capital flows play a more significant role in East Asia, with spillovers from the US factoring in. Moreover, since the Great Financial Crisis of 2008-09, central banks have expanded their purview beyond the business cycle to give more attention to financial stability.
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