Hostname: page-component-6898cfcb55-cbk24 Total loading time: 0 Render date: 2026-11-11T10:15:09.135Z Has data issue: false hasContentIssue false
  • English
  • Français

THE OUTPUT EULER EQUATION AND REAL INTEREST RATE REGIMES

Published online by Cambridge University Press:  11 July 2017

Pym Manopimoke
Pym Manopimoke*
Affiliation:
Bank of Thailand
*
Address correspondence to: Pym Manopimoke, Puey Ungphakorn Institute for Economic Research, Bank of Thailand, 273 Samsen Road, Watsamphraya, Phra Nakhon District, Bangkok 10200, Thailand; e-mail: pymm@bot.or.th.
Rights & Permissions [Opens in a new window]

Abstract

Core share and HTML view are not available for this content. However, as you have access to this content, a full PDF is available via the 'Save PDF' action button.

Output Euler equations (OEE) for the US deliver slope estimates that are not significantly different from zero. This finding is counterintuitive as it implies a zero elasticity of intertemporal substitution (EIS) and aggregate demand movements that are nonresponsive to the short-term real interest rate. This paper shows that failure to account for regime changes in the dynamics of the real interest rate is responsible for this result. Based on a joint specification for the OEE and the real interest rate in an unobserved components model framework with Markov-switching parameters, the means, variances, and degrees of persistence of the real interest rate are different for the periods 1966–1980, 1980–1985, and 1985–2015. Once these regime changes are taken into account, the EIS estimate is 0.1 and no longer statistically insignificant. This finding is robust to alternative measures of the output gap as well as different specifications for the natural real interest rate.

Keywords

Output Euler EquationMarkov-SwitchingReal Interest RateElasticity of Intertemporal Substitution

Information

Type
Articles
Information
Macroeconomic Dynamics , Volume 23 , Issue 1 , January 2019, pp. 420 - 447
Copyright
Copyright © Cambridge University Press 2017 

References

REFERENCES

Atkeson, Andrew and Ogaki, Masao (1996) Wealth-varying intertemporal elasticities of substitution: Evidence from panel and aggregate data. Journal of Monetary Economics 38 (3), 507–534.Google Scholar
Attanasio, Orazio P. and Weber, Guglielmo (1993) Consumption growth, the interest rate and aggregation. Review of Economic Studies 60 (3), 631–649.Google Scholar
Attanasio, Orazio P. and Browning, Martin (1995) Consumption over the life cycle and over the business cycle. American Economic Review 85 (5), 1118–1137.Google Scholar
Bai, Jushan and Perron, Pierre (2003) Computation and analysis of multiple structural change models. Journal of Applied Econometrics 18 (1), 1–22.Google Scholar
Barksy, Robert, Justiniano, Alejandro, and Melosi, Leonardo (2014) The natural rate and its usefulness for monetary policy making. American Economic Association 104 (5), 37–43.Google Scholar
Basdevant, Olivier, Björksten, Nils, and Karagedikli, Özer (2004) Estimating a time varying neutral real interest rate for New Zealand. Reserve Bank of New Zealand discussion paper 2004/01.Google Scholar
Bilbiie, Florin O. and Straub, Roland (2012) Changes in the output Euler equation and asset markets participation. Journal of Economic Dynamics and Control 36 (11), 1659–1672.Google Scholar
Boivin, Jean and Giannoni, Marc (2002) Assessing changes in the monetary transmission mechanism: A VAR approach. Federal Reserve Bank of New York Economic Policy Review 8 (1), 97–111.Google Scholar
Boivin, Jean and Giannoni, Marc (2006) Has monetary policy become more effective? Review of Economics and Statistics 88 (3), 445–462.Google Scholar
Boivin, Jean, Kiley, Michael T., and Mishkin, Frederic S. (2010) How has the monetary transmission mechanism evolved over time? NBER working paper no. 15879.Google Scholar
Campbell, John Y. (2003) Consumption-based asset pricing. In Constantinides, George M., Harris, Milton, and Stulz, Rene M. (eds.), Handbook of the Economics of Finance, vol. 1B, pp. 803–887. Amsterdam: North-Holland.Google Scholar
Campbell, John Y. and Mankiw, Gregory (1989) Consumption, income and interest rates: Reinterpreting the time series evidence. In Blanchard, Olivier J. and Fischer, Stanley (eds.), NBER Macroeconomic Annual 1989, vol. 4, pp. 185–216. Cambridge, MA: MIT Press.Google Scholar
Canova, Fabio and Gambetti, Luca (2005) Structural changes in the US economy: Bad luck or bad policy? CEPR discussion paper no. 5457.Google Scholar
Chiappori, Pierre-Andŕe and Paiella, Monica (2011) Relative risk aversion is constant: Evidence from panel data. Journal of the European Economic Association 9 (6), 1021–1052.Google Scholar
Clarida, Richard, Gali, Jordi, and Gertler, Mark (2000) Monetary policy rules and macroeconomic stability: Evidence and some theory. The Quarterly Journal of Economics 115 (1), 147–180.Google Scholar
Cogley, Timothy and Sbordone, Argia M. (2008) Trend inflation, indexation, and inflation persistence in the New Keynesian Phillips curve. American Economic Review 98 (5), 2101–2126.Google Scholar
Cour-Thimann, Philppine, Pilegaard, Rasmus, and Stracca, Livio (2006) The output gap and the real interest rate gap in the euro area, 1960–2003. Journal of Policy Modeling 28 (7), 775–790.Google Scholar
Fuhrer, Jeffrey C. (2000) Habit formation in consumption and its implications for monetary-policy models. American Economic Review 90 (3), 367–390.Google Scholar
Fuhrer, Jeffrey C. and Estrella, Arturo (2003) Are ‘deep’ parameters stable? The Lucas Critique as an empirical hypothesis. Review of Economics and Statistics 85 (1), 94–104.Google Scholar
Fuhrer, Jeffrey C. and Olivei, Giovanni (2004) Estimating forward-looking euler equations with GMM estimators: An optimal instruments approach. Federal Reserve Bank of Boston working paper no. 04-2.Google Scholar
Fuhrer, Jeffrey C. and Rudebusch, Glenn D. (2004) Estimating the Euler equation for output. Journal of Monetary Economics 51 (6), 1133–1153.Google Scholar
Gali, Jordi (1992) How well does the IS-LM model fit postwar U.S. data? Quarterly Journal of Economics 107 (2), 709–738.Google Scholar
Garcia, Rene and Perron, Pierre (1996) An analysis of the real interest rate under regime shifts. The Review of Economics and Statistics 78 (1), 111–125.Google Scholar
Giammarioli, Nicola and Valla, Natacha (2003) The natural rate of interest in the euro area. ECB working paper no. 0233.Google Scholar
Goodhart, Charles and Hofmann, Boris (2005) The IS curve and the transmission of monetary policy: Is there a puzzle? Applied Economics 37 (1), 29–36.Google Scholar
Guvenen, Fatih (2006) Reconciling conflicting evidence on the elasticity of intertemporal substitution: A macroeconomic perspective. Journal of Monetary Economics 53 (7), 1451–1472.Google Scholar
Hall, Robert E. (1988) Intertemporal substitution in consumption. Journal of Political Economy 96 (2), 339–357.Google Scholar
Hansen, Bruce E. (1992) The likelihood ratio test under nonstandard conditions: Testing the Markov trend model of GNP. Journal of Applied Econometrics 7, S61–S82.Google Scholar
Huizinga, John and Mishkin, Frederic S. (1986) Monetary policy regime shifts and the unusual behavior of real interest rates. Carnegie-Rochester Conference Series on Public Policy 24 (1), 231–274.Google Scholar
Jones, Larry E., Manuelli, Rodolfo E., and Stacchetti, Ennio (2000) Technology (and Policy) shocks in models of endogenous growth. Federal Reserve Bank of Minneapolis Staff Report no. 281.Google Scholar
Justiniano, A. and Primiceri, Giorgio (2008) The time-varying volatility of macroeconomic fluctuations. The American Economic Review 98 (3), 604–641.Google Scholar
Justiniano, Alejandro, Primiceri, Giorgio E., and Tambalotti, Andrea (2013) Is there a trade-off between inflation and output stabilization? American Economic Journal: Macroeconomics 5 (2), 1–31.Google Scholar
Kiley, Michael T. (2015) What can the data tell us about the equilibrium real interest rate? Board of Governors of the Federal Reserve System discussion paper no. 2015-077.Google Scholar
Kim, Chang-Jin (1994) Dynamic linear models with Markov-switching. Journal of Econometrics 60 (1–2), 1–22.Google Scholar
Kim, Chang-Jin and Kim, Jaeho (2015) Bayesian inference in regime-switching ARMA models with absorbing states: The dynamics of the ex-ante real interest rate under regime shifts. Journal of Business & Economic Statistics 33 (4), 566–578.Google Scholar
Kim, C. J., Manopimoke, Pym, and Nelson, Charles R. (2014) Trend inflation and the nature of structural breaks in the New Keynesian Phillips curve. Journal of Money, Credit and Banking 46 (2–3), 253–266.Google Scholar
Kim, Chang-Jin and Nelson, Charles R. (1999) Has the US economy become more stable? A Bayesian approach based on a Markov-switching model of the business cycle. Review of Economics and Statistics 81 (4), 608–616.Google Scholar
King, Robert G. and Rebelo, Sergio (1990) Public policy and economic growth: Developing neoclassical implications. Journal of Political Economy 98 (5), S126–S150.Google Scholar
King, Robert G., Plosser, Charles I., Stock, James H., and Watson, Mark W. (1991) Stochastic trends and economic fluctuations. American Economic Review 81 (4), 819–840.Google Scholar
Koustas, Zisimos and Serletis, Apostolos (1999) On the Fisher effect. Journal of Monetary Economics 44 (1), 105–130.Google Scholar
Kozicki, Sharon and Tinsley, Peter A. (2002) Alternative sources of lag dynamics of inflation. FRB Kansas City Research working paper no. 02–12.Google Scholar
Kydland, Finn E. and Prescott, Edward C. (1982) Time to build and aggregate fluctuations. Econometrica: Journal of the Econometric Society 40, 1345–1370.Google Scholar
Larsen, Jens D. J. and McKeown, Jack (2004) The information content of empirical measures of real interest rate and output gaps for the United Kingdom. Bank of England working paper no. 224.Google Scholar
Laubach, Thomas and Williams, John (2003) Measuring the natural rate of interest. Review of Economics and Statistics 85 (4), 1063–1070.Google Scholar
Lubik, Thomas A. and Schorfheide, Frank (2004) Testing for indeterminacy: An application to U.S. monetary policy. American Economic Review 94 (1), 190–219.Google Scholar
Mankiw, N. Gregory (1981) The permanent income hypothesis and the real interest rate. Economics Letters 7 (4), 307–311.Google Scholar
Manopimoke, Pym (2009) An analysis of the real interest rate and monetary policy under regime shifts. Thammasat Economic Journal 27 (2), 1–36.Google Scholar
McConnell, Margeret M. and Perez-Quiros, Gabriel (2000) Output fluctuations in the United States: What has changed since the early 1980s? American Economic Review 90 (5), 1464–1476.Google Scholar
Mishkin, Frederic S. (1981) The real rate of interest: An empirical investigation. National Bureau of Economic Research no. 0622.Google Scholar
Neely, Christopher J. and Rapach, David E. (2008) Real interest rate persistence: Evidence and implications. Federal Reserve Bank of St. Louis Review 90 (6), 609–641.Google Scholar
Neiss, Katharine S. and Nelson, Edward (2003) The real rate gap as an inflation indicator. Macroeconomic Dynamics 7, 239–262.Google Scholar
Perron, Pierre (1990) Testing for a unit root in a time series with a changing mean. Journal of Business & Economic Statistics 8 (2), 153–162.Google Scholar
Rapach, David E. and Wohar, Mark E. (2005) Regime changes in international real interest rates: Are they a monetary phenomenon? Journal of Money, Credit and Banking 37 (5), 887–906.Google Scholar
Rose, Andrew K. (1988) Is the real interest rate stable? Journal of Finance 43 (5), 1095–1112.Google Scholar
Rudebusch, Glenn D. (2002) Assessing nominal income rules for monetary policy with model and data uncertainty. The Economic Journal 112 (479), 402–432.Google Scholar
Rudebusch, Glenn D. and Svensson, Lars E. O. (1999) Policy rules for inflation targeting. In Taylor, John B. (ed.), Monetary Policy Rules, pp. 203–262. Chicago, IL: University of Chicago Press.Google Scholar
Sims, Christopher A. and Zha, Tao (2006) Were there regime switches in US monetary policy? American Economic Review 96 (1), 54–81.Google Scholar
Smets, Frank and Wouters, Raf (2003) An estimated dynamic stochastic general equilibrium model of the euro area. Journal of the European Economic Association 1 (5), 1123–1175.Google Scholar
Stock, James H. and Watson, Mark W. (1998) Median unbiased estimation of coefficient variance in a time-varying parameter model. Journal of the American Statistical Association 93 (441), 349–358.Google Scholar
Stracca, Livio (2010) Is the New Keynesian IS Curve Structural? European Central Bank working paper no. 1236.Google Scholar
Summers, Lawrence H. (1984) The after-tax rate of return affects private savings. American Economic Review 74 (2), 249–253.Google Scholar
Svensson, Lars E. O. (1999) Inflation targeting: some extensions. Scandinavian Journal of Economics 101 (3), 337–361.Google Scholar
Trostel, Philip A. (1993) The effect of taxation on human capital. The Journal of Political Economy 101 (2), 327–350.Google Scholar
Vissing-Jørgensen, Annette (2002) Limited asset market participation and the elasticity of intertemporal substitution. Journal of Political Economy 110 (4), 825–853.Google Scholar
Weil, Philippe (1989) The equity premium puzzle and the risk-free rate puzzle. Journal of Monetary Economics 24 (3), 401–421.Google Scholar
Woodford, Michael (2011) Interest and Prices: Foundations of a Theory of Monetary Policy. Princeton, NJ: Princeton University Press.Google Scholar
Yogo, Motohiro (2004) Estimating the elasticity of intertemporal substitution when instruments are weak. The Review of Economic and Statistics 86 (3), 797–810.Google Scholar