The behaviour of real interest rates: New evidence from a 'suprasecular' perspective

Abstract

We examine the temporal dynamics of the historical series of real interest rates for France, Germany, Italy, Japan, the Netherlands, Spain pre-1730 and post-1800, the United Kingdom, and the United States stretching back to the 14th century. We use the Robinson approach to determine the fractional order of integration and examine both linear deterministic trends and multiple smooth breaks. In the latter case we make use of the Chebyshev polynomials in time. With the exception of two countries (Italy and France), where the linear model appears more appropriate, our results reveal evidence that real interest rates are driven by the interaction between nonlinearities in the deterministic trends and fractional integration processes. They suggest that real interest rates are mean-reverting but not as persistent as suggested in the literature. In particular, the nonlinear model with autocorrelated errors provides no evidence of long memory, which questions most of the literature on real interest rates. The implications of these results are relevant to evaluate the effectiveness of policy interventions and the theoretical implications of different macroeconomic models as shocks affecting real interest rates will dissipate by themselves.