Reexamining the long-run properties of the real interest rate

In the empirical literature, stationary and nonstationary behavior has been reported for the U.S. real interest rate over di¤erent time periods. We examine its long-run properties, through estimation of the order of integration, and interpret the results in light of the Taylor rule for monetary policy. When concentrating on the post-October 1987 period, our analysis suggests that the business cycle component of the real interest rate dominates its trend. Under such a setup, we argue on the basis of a theoretical example and a simulation study that, in …nite samples, the estimator of the order of integration recovers information on the strength of the cycle, rather than the trend. For that reason, we extract the cyclical part of the real interest rate, and obtain considerably lower estimates of the order of integration. We therefore conjecture that in the post-October 1987 period, the estimates of the order of integration for the real interest rate are uninformative, and that its degree of long-run dependence has been overestimated. JEL Classi…cation: C22, E32.