Giorgio Canarella and Stephen M. Miller (both Economics and Center for Business and Economic Research) published International Finance 2021 with co-authors, Luis A Gil-Alana, University of Navarra, Pamplona, Spain, and Rangan Gupta, University of Pretoria in South Africa. Thry examine the temporal dynamics of historical real interest rates for six European countries (France, Germany, Italy, the Netherlands, Spain, and the UK), the U.S., and Japan stretching back to the 14th century. They use the fractional order of integration to examine both linear deterministic trends and multiple smooth breaks. With the exception of Italy and France where the linear model appears more appropriate, the results reveal that real interest rates are driven by the interaction between non-linearities in the deterministic trends and fractional integration processes. They suggest that real interest rates are mean-reverting but not as persistent as suggested in the literature. The nonlinear model with auto-correlated errors provides no evidence of long memory, which questions most of the literature on real interest rates. The implications of these results are relevant to evaluate the effectiveness of policy interventions and the theoretical implications of different macroeconomic models as shocks affecting real interest rates will recover by themselves.
