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Unlikely Estimates of the Ex Ante Real Interest Rate: Another Dismal Performance from the Dismal Science1

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  • Lee C. Spector

    ()
    (Department of Economics, Ball State University)

  • Courtenay C. Stone

    ()
    (Department of Economics, Ball State University)

Abstract

The ex ante real rate of interest is one of the most important concepts in economics and finance. Because the universally-used Fisher theory of interest requires positive ex ante real interest rates, empirical estimates of the ex ante real interest rate derived from the Fisher theory of interest should also be positive. Unfortunately, virtually all estimates of the ex ante real interest rate published in economic journals and textbooks or used in macroeconomic models and policy discussions for the past 35 years contain negative values for extended time periods and, thus, are theoretically flawed. Moreover, the procedures generally used to estimate ex ante real interest rates were shown to produce biased estimates of the ex ante real rate over 30 years ago. In this article, we document this puzzling chasm between the Fisherian theory that mandates positive ex ante real interest rates and the practice of macroeconomists who generate and use ex ante real interest rate estimates that violate this theory. We explore the reasons that this problem exists and assess some alternative approaches for estimating the ex ante real interest rate to determine whether they might resolve this problem.

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File URL: http://econfac.iweb.bsu.edu/research/workingpapers/bsuecwp201010r3spector.pdf
File Function: First version, October 2010
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Bibliographic Info

Paper provided by Ball State University, Department of Economics in its series Working Papers with number 201010.

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Length: 42 pages
Date of creation: Oct 2010
Date of revision: Jan 2011
Handle: RePEc:bsu:wpaper:201010

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Keywords: ex ante real interest rate; Fisher theory of interest; biased real interest rate estimates;

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  1. Bullard, James B., 2013. "Seven Faces of "The Peril"," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 613-628.
  2. William T. Gavin & Benjamin D. Keen & Michael R. Pakko, 2005. "The monetary instrument matters," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 633-658.
  3. William T. Gavin, 2010. "Deflation and the Fisher equation," Economic Synopses, Federal Reserve Bank of St. Louis.
  4. Alejandro Justiniano & Giorgio E. Primiceri, 2010. "Measuring the equilibrium real interest rate," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q I, pages 14-27.
  5. Ernst Juerg Weber, 2007. "The Role of the Real Interest Rate in US Macroeconomic History," Economics Discussion / Working Papers 07-01, The University of Western Australia, Department of Economics.
  6. Ferraro Paul J & Taylor Laura O, 2005. "Do Economists Recognize an Opportunity Cost When They See One? A Dismal Performance from the Dismal Science," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 4(1), pages 1-14, September.
  7. Philip R. P. Coelho & James E. McClure, 2005. "Theory versus Application: Does Complexity Crowd Out Evidence?," Southern Economic Journal, Southern Economic Association, vol. 71(3), pages 556-565, January.
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