Do Monetary Policy Shocks Affect the Neutral Rate of Interest? 
The conventional assumption has been that the real neutral rate of interest (
) is determined by slow-moving structural forces that are outside monetary policymakers’ control. However, recent studies challenge this view, suggesting monetary policy may have more persistent effects on than previously thought. This paper empirically tests whether monetary policy shocks affect and quantifies the importance of such shocks relative to other factors. It develops a framework that allows cyclical disturbances to affect trend components, addressing a limitation in previous models that assume trend–cycle orthogonality.
Key Findings
- Using a trend–cycle Bayesian vector autoregression (TC-BVAR) model, the authors find that contractionary monetary policy shocks (unexpected increases in short-term interest rates) have a statistically significant negative effect on .
- While monetary policy shocks generated notable fluctuations in during the 2001 and 2008–2009 recessions, their contribution to the long-term (beginning in the early 1990s) downward trend in has been limited.
- The aggregate effect of monetary policy shocks on over the sample period (1988 through 2019) was slightly positive, suggesting monetary policy may have prevented the rate from declining further.
- The effect of monetary policy on operates primarily through real-economy channels (via persistent effects on trend GDP growth) rather than through financial market channels (term premiums).
- Similar patterns were observed across other advanced economies (the United Kingdom, the euro area, Canada, and Japan), with contractionary monetary policy shocks negatively affecting .
Implications
The paper’s findings indicate that while monetary policy can affect , the secular decline in the rate has been driven primarily by structural factors (demographics, productivity trends, inequality). Thus, the paper reconciles the conventional view that long-run movement in is driven by structural forces with the emerging evidence that monetary policy can influence trend components of the economy.
Abstract
We develop a trend–cycle Bayesian vector autoregression that jointly estimates the real neutral rate of interest, 
, and identifies monetary policy shocks. As a key innovation, the framework allows cyclical shocks, most notably monetary policy shocks, to affect the trend component of macroeconomic variables, providing a new way to assess whether transitory disturbances have persistent effects. Using external instruments, we find that contractionary monetary policy shocks reduce and lower trend GDP growth, while the model’s estimates of remain consistent with standard benchmark measures. We then quantify the contribution of monetary policy shocks to the secular decline in . Although these shocks at times generate sizable movements in , their contribution to the long-run decline is modest, and their net effect on since the
early 1990s is slightly positive. We complement these findings with cross-country evidence from other advanced economies, pointing to similar effects.