Bank for International Settlements working paper argues persistent policy-rate shifts can move long-term real rates with limited effects on activity

The Bank for International Settlements published a working paper examining why long-term real interest rates often move closely with central banks’ policy rates, proposing that highly persistent policy-induced rate changes can have only weak effects on output and inflation once life-cycle consumption and retirement-saving motives are taken into account. In this setting, precisely pinning down the natural rate of interest (r-star) becomes less central for policy because real rates could remain away from r-star for prolonged periods without large macroeconomic consequences. The paper develops a Finitely-Lived Agent New Keynesian (FLANK) model in which intertemporal substitution and asset-valuation effects from interest rate changes are partly offset by interest-income effects that alter desired asset demand for retirement savings. This can make monetary transmission vary along the yield curve: short-term real rate increases remain contractionary, while changes further out can be much weaker or even reverse sign when the elasticity of intertemporal substitution is below one, implying persistent “low-for-long” policies may primarily affect asset valuations rather than aggregate demand. Supporting evidence includes US data showing consumption comoves far more with interest-rate-adjusted wealth than with raw wealth, and local-projection results using high-frequency “target” (short-end) versus “path” (longer-end) shocks for the United States, euro area and United Kingdom, where unemployment responds more conventionally to target shocks while path shocks show small or perverse effects; the paper also argues this environment can bias common r-star estimation approaches toward central banks’ own perceived r-star.