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The natural rate of interest through a hall of mirrors

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  • Rungcharoenkitkul, Phurichai
  • Winkler, Fabian

Abstract

We propose a novel explanation for persistent movements in the natural rate of interest, or r-star, based on a model of two-sided learning between the central bank and the private sector. Each side has some information about r-star fundamentals and also learns from observing output, inflation and interest rates. When both sides fail to recognise that their actions influence the other’s beliefs, a “hall-of-mirrors” effect arises that causes persistent shifts in r-star in response to cyclical shocks. The model can explain the post-2008 decline in r-star without changes in long-run fundamentals, as well as the excess sensitivity of long-term yields to monetary policy surprises and the underreaction of interest rate forecasts. Aggressive policy easing designed to counter a recession can inadvertently lower r-star and endogenously narrow policy space.

Suggested Citation

  • Rungcharoenkitkul, Phurichai & Winkler, Fabian, 2026. "The natural rate of interest through a hall of mirrors," Journal of Monetary Economics, Elsevier, vol. 157(C).
    • Handle: RePEc:eee:moneco:v:157:y:2026:i:c:s0304393225001291
    DOI: 10.1016/j.jmoneco.2025.103858
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    1. is not listed on IDEAS
    2. Ivan Todorov, 2025. "Еconomic Policy Under Global Flight to Safe Assets and Effective Lower Bound: the Bulgarian Prospects," Economic Alternatives, University of National and World Economy, Sofia, Bulgaria, issue 4, pages 1200-1218, Desember.
    3. Melissa van Rensburg, 2023. "Long-run trends in New Zealand’s real neutral interest rate," Treasury Analytical Notes Series an23/05, New Zealand Treasury.
    4. Claudio Borio, 2021. "Back to the Future: Intellectual Challenges for Monetary Policy," Economic Papers, The Economic Society of Australia, vol. 40(4), pages 273-287, December.
    5. Agustin G. Carstens, 2022. "Jackson Hole 2022 - Luncheon Address: A Story of Tailwinds and Headwinds: Aggregate Supply and Macroeconomic Stabilization," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, August.
    6. Gianluca Benigno & Boris Hofmann & Galo Nuño Barrau & Damiano Sandri, 2024. "Quo vadis, r*? The natural rate of interest after the pandemic," BIS Quarterly Review, Bank for International Settlements, March.
    7. Agnello, Luca & Castro, Vítor & Sousa, Ricardo M., 2022. "On the international co-movement of natural interest rates," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 80(C).
    8. Garabedian, Garo, 2025. "Star-struck; Monetary Policy and the Neutral Rate," Research Technical Papers 4/RT/25, Central Bank of Ireland.
    9. Grishchenko, V. & Sinyakov, A., 2024. "Demography and equilibrium interest rates: Competing approaches and evidence from Russia," Journal of the New Economic Association, New Economic Association, vol. 62(1), pages 229-239.
    10. Claudio Borio, 2021. "Navigating by r*: safe or hazardous?," BIS Working Papers 982, Bank for International Settlements.

    More about this item

    Keywords

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    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness

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