Structural Shocks and the Comovements between Output and Interest Rates

Stylized facts on U.S. output and interest rates have so far proved hard to match with simple DSGE models. I estimate covariances between output, nominal and real interest rate conditional on structural shocks, since such evidence has largely been lacking in previous discussions of the output-interest rate puzzle. Conditional on shocks to technology and monetary policy, the results square with simple models. Moreover, permanent inflation shocks accounted for the counter-cyclical and inversely leading behavior of the real rate during the Great Inflation (1959–1979). Over the Great Moderation (1982–2006), technology shocks were more dominant and the real rate has been pro-cyclical.