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What is the Real Story for Interest Rate Volatility?

Author

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  • Hornstein Andreas

    (Federal Reserve Bank of Richmond, VA,Virginia, United States of America)

  • Uhlig Harald

    (CentER, Tilburg University, CEPR,Tilburg, Netherlands)

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 the fluctuations of real rates 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 and Donaldson, Jermann, and Boldrin, Christiano and 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

  • Hornstein Andreas & Uhlig Harald, 2000. "What is the Real Story for Interest Rate Volatility?," German Economic Review, De Gruyter, vol. 1(1), pages 43-67, February.
    • Handle: RePEc:bpj:germec:v:1:y:2000:i:1:p:43-67
    DOI: 10.1111/1468-0475.00004
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    3. Willi Semmler, 2011. "Asset Prices, Booms and Recessions," Springer Books, Springer, number 978-3-642-20680-1, December.
    4. Scheffel, Eric, 2008. "Consumption Velocity in a Cash Costly-Credit Model," Cardiff Economics Working Papers E2008/31, Cardiff University, Cardiff Business School, Economics Section.

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