Staff Working Paper No. 1,117
By Paul Beaudry, Paolo Cavallino and Tim Willems
This paper presents theory and evidence to advance the notion that very persistent policy‑induced interest rate changes may have only weak effects on activity. This arises when consumption‑savings decisions are not primarily driven by intertemporal substitution, but also by life‑cycle forces. The small impact of persistent rate changes results when intertemporal substitution and asset valuation effects are offset by interest income effects, which affect asset demand. In our framework, knowing the exact location of r* becomes less critical to central banks, as interest rates can be kept away from this level for prolonged periods of time, allowing monetary policy to unconsciously drive trends in real rates. This perspective offers an explanation to a set of puzzles, including why long‑term real rates often move quite closely with short‑term policy rates.
Monetary policy along the yield curve: why can central banks affect long-term real rates?