The Korean Economic Forum
Estimation of the Neutral Real Interest Rate with Household Credit Gap
Hyoung-Seok Oh (Bank of Korea) and Jiuk Choi (Citibank Korea Inc.)Year 2023Vol. 15No. 4
AbstractThe Laubach and Williams(2003) model has been widely used to estimate the neutral real interest rate(r*). However, crucial limitations have been continuously raised since the model cannot reflect the impact of financial conditions on the real economy. In Korea, household credit has increased significantly since the second half of 2014. Thus many economists worry about the possibility that the high level of household credit in Korea appears to contract private consumption and negatively affect long-term growth. Considering household credit conditions in Korea, this paper analyzed the neutral real interest rate using a model that explicitly reflects the effect of the household credit cycle on growth. We find that the neutral real interest rate level during the household credit cycle expansion period is higher than that estimated from the original Laubach and Williams(2003) method. Accordingly, the neutral real interest rate and monetary policy stance under excessive credit growth should be carefully estimated and assessed.