Neutral interest rate in the Czech Republic: Alternative approach based on application of TVP-VAR model

Abstract

Our objective is the estimation of the neutral interest rate in the Czech Republic spanning January 2002 to De- cember 2020. Employing the Bayesian Time-Varying Parameters (TVP) model with local prior shrinkage, our novel contribution to the existing knowledge of neutral interest rates involves the development of an estimation method utilizing the TVP-VAR model. This approach represents a modern and flexible paradigm applied within the Czech Republic's economic environment, where it has not been employed previously. Notably, our chosen econometric framework eliminates the often-challenging task of defending theoretical links. The TVP-VAR model relies on modest economic assumptions concerning the structure of a given economy, with estimates derived from empirical economic relationships among variables that contribute to the neutral interest rate. While the theory of neutral interest rates boasts a rich historical development anchored in the work of economic luminar- ies, recent years have unveiled it as a compelling subject for ongoing research. Despite being an unobserved variable, we illuminate the developmental trends of the neutral interest rate within the domestic economy. In the Czech Republic, our findings indicate a sustained and gradual decline in the neutral interest rate, settling at a negative level of approximately -0.5%. Remarkably, the neutral interest rate exhibits a stable trajectory. Compara- tive analysis with analogous surveys conducted in the euro area reveals a robust co-movement between the neutral interest rates in the Czech Republic and the euro area.