THE NATURAL RATE OF INTEREST AND ITS APPLICATIONS TO THE SINGAPORE ECONOMY.

Abstract

This paper estimates the natural rate of interest for Singapore and applies the results in two ways. The real rate gap is firstly incorporated in a VAR model to study the interest rate channel of Singapore’s monetary transmission. It is found to narrow with statistical significance following a contractionary monetary policy shock, thereby validating the presence of an interest rate channel. Variances in output and inflation are also significantly accounted for by the real rate gap but it is secondary to exchange rate movements. Secondly, domestic and world determinants of Singapore’s natural rate of interest were considered in a stepwise regression model to analyse saving-investment dynamics. Domestic and world variables present very different effects on Singapore’s natural rate of interest, but demographic variables are the overall driving factor.