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What is the real story for interest rate volatility?

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  • Andreas Hornstein
  • Harald F. Uhlig

Abstract

What is the source of interest rate volatility? Why do low interest rates precede business cycle booms? Most observers tend to assume that monetary policy is largely responsible for it. Indeed, a standard real business cycle model delivers rather small fluctuations in real interest rates. Here, however, we present two models of the real business cycle variety in which real rate fluctuations are of similar magnitude as in the data, while simultaneously matching salient business cycle facts. The second model also replicates the cyclical behavior of real interest rates. The models build on recent work by Danthine-Donaldson, Jermann, and Boldrin-Christiano-Fisher. We assume that there are workers and capital owners. The first model posits habit formation and adjustment costs to the stock of capital. The second model assumes that it takes time to plan investment and time to build capital.

Suggested Citation

  • Andreas Hornstein & Harald F. Uhlig, 1999. "What is the real story for interest rate volatility?," Working Paper 99-09, Federal Reserve Bank of Richmond.
  • Handle: RePEc:fip:fedrwp:99-09
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    2. Scheffel, Eric, 2008. "Consumption Velocity in a Cash Costly-Credit Model," Cardiff Economics Working Papers E2008/31, Cardiff University, Cardiff Business School, Economics Section.
    3. Willi Semmler, 2011. "Asset Prices, Booms and Recessions," Springer Books, Springer, number 978-3-642-20680-1, January.

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