Author : Kyeongtak Do(Bank of Korea), Ju Hyun Ahn(Bank of Korea), Hae Ri Jung(Bank of Korea)

<Abstract>

To explore the historical and recent developments of the natural interest rate (NIR) in Korea, this paper estimates the long-run NIR using four different models, including semi-structural and time-series models, taking into account Korea's characteristics as a small open economy. Prior to the COVID-19 outbreak, the NIR followed a declining trend, ranging from 1.4 - 3.1% in the first quarter of 2000, to –1.1 - 0.5% in the first quarter of 2020. However, in the post-pandemic period, this downward trend appears to have paused and reversed, with the most recent estimate for the first quarter of 2024 ranging between –0.2 - 1.3%. Given the limited post-pandemic data, however, the upward shift should be reassessed as more data becomes available. Next, NIR estimates vary significantly across different methodologies, with the latest range between the highest and lowest estimates being approximately 1 - 2%p. Additionally, these estimates exhibit significant uncertainty, with large statistical confidence bands surrounding each estimate. Given the inherent uncertainty in the estimates, caution is advised against relying solely on the NIR to assess the monetary policy stance. Lastly, results show that a considerable proportion of the fluctuations in the NIR in Korea can be attributed to the influence of external factors. During the period of low U.S. Fed policy rates after the Global Financial Crisis, the model with external variables estimated the NIR to be on average 0.4%p lower than the model without them. Conversely, during the post-pandemic period of higher policy rates, the NIR estimate from the external model was, on average, 0.3%p higher.