Monetary Policy Regimes and the Real Interest Rate

Abstract

During the period from 1965 to the end of 2015, the Federal Reserve operated monetary policy in a variety of ways associated with four distinct monetary policy regimes. These different monetary policy regimes display different outcomes for inflation, interest rates, and real consumption growth. This article uses the differences among the outcomes to better understand how monetary policy affects those outcomes. One of the important results is that monetary policy appears to be able to affect long-term real interest rates and real consumption growth during periods of extreme monetary policy in which the Fed holds short-term interest rates abnormally high or abnormally low for an extended period. This article exploits the idea of monetary policy regimes to ask whether monetary policy exacerbated the low real interest rate on safe assets and the low level of consumption during the period in which the range for the Fed’s interest rate target was set at 0 to 0.25 percent. Many observers have appealed to real factors such as aging demographics to explain the low level of long-term interest rates. The evidence presented here suggests that policy analysts should also consider the possibility that the Fed was the main cause of the low real interest rate following the 2007-08 financial crisis.