Staff Working Paper No. 1,117
By Paul Beaudry, Paolo Cavallino and Tim Willems
Real interest rates are widely considered to be driven by real forces over time, with monetary policy having only short-lived effects. We present theory and evidence suggesting instead that monetary policy may (unintentionally) contribute to low-frequency dynamics in real rates. We first show how temporary demand shocks generate persistent movements in forward real rates and r*-estimates. We then demonstrate how such ‘real rate hysteresis’ emerges if the central bank overestimates the sensitivity of aggregate demand to permanent real-rate changes when inferring r*. Such overestimation can arise if the central bank insufficiently incorporates life-cycle forces in its model of r*.
This version was updated in August 2026.
Monetary policy along the yield curve: why can central banks affect long-term real rates?
