Supply Shocks and the "Natural Rate of Interest": an Exploration

Abstract

We develop two variants of an open economy general equilibrium model employing Blanchard-Yaari life overlapping generations, which are shown to capture a number of important aspects of the UK economic cycle. We analyse the equilibrium stochastic processes of the model�s endogenous variables in response to two primitive driving processes: total factor productivity and various measures of total factor productivity corrected for capacity utilisation over the cycle. We find, following Vickers� (2000) suggestion, that the marginal product of capital is procyclical. Interestingly, we find that the difference between the procyclical real rate from the artificial economies and the observed real rate seems to play a role in explaining the UK inflation and output outcomes.