Money and the Natural Rate of Interest: Structural Estimates for the United States and the Euro Area

We examine the role of money in a general framework that allows for three competing environments: the New Keynesian model with separable utility and static money demand; the non-separable utility variant with habit formation; and the New Keynesian model modi…ed to allow for adjustment costs for holding real balances. The last two models imply a forward-looking character of real money balances, that conveys on money an important role as a monetary policy indicator. We distinguish between these alternative speci…cations by conducting a structural econometric analysis for the U.S. and the euro area. FIML estimates con…rm the forward-looking character of money demand. Using these estimates we …nd that, in response to preferences and technology shocks, money incorporates useful information regarding future variations in the natural interest rate. and the Bundesbank for helpful comments and conversations, and Thomas Westermann for help in obtaining data. Jason Buol and Justin Hauke provided research assistance. The views expressed in this paper are those of the authors and should not be interpreted as those of the Federal Reserve Bank of St. Louis, the Federal Reserve System, or the Board of Governors.

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