Does monetary policy affect the long-run expectations of non-stationary real interest rates?

In this article, we analyse whether the monetary policy affects the long-run expectation of the non-stationary real interest rate. The analysis is conducted through Beveridge–Nelson trend decomposition within a cointegrated vector autoregressive model based on the New Keynesian framework. We suggest an augmented test of the conventional co-integration test on the non-stationarity of the real interest rate, which checks whether the co-integration coefficient of inflation is one and the output gap affects the co-integration equilibrium of the nominal interest rate. We further suggest decomposing the long-run expectation of the non-stationary real interest rate into three trends: the interest rate shock (including the monetary shock), inflation shock and output gap shock. According to empirical analyses using monthly US data after the Korean War, the long-run expectation of the non-stationary real interest rate contains an interest rate shock trend and the impulse of the federal fund target rate induces a significant response of the interest rate shock trend. However, the interest rate shock trend has a very small portion of the long-run expectation of the non-stationary real interest rate, which may explain why the monetary policy was not particularly effective in the economic recovery after the global financial crisis.