Wicksell's Classical Dichotomy: is the Natural Rate of Interest Independent of the Money Rate of Interest?

19/12/2005 |  Beenstock Michael, Ilek Alex
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Monetary Policy and Inflation
Wicksell's Classical Dichotomy: is the Natural Rate of Interest Independent of the Money Rate of Interest?
Michael Beenstock and Alex Ilek

Abstract

Proponents of Taylor Rules assume that the natural rate of interest is independent of the rate of interest set by the central bank. We use data for Israel to test this hypothesis. We proxy the natural rate of interest by the forward yield to maturity on indexed-linked treasury bonds. If the null hypothesis is false it is difficult to suggest persuasive instruments that would identify the causal effect of the money rate on the natural rate of interest. Our identification strategy is therefore built around natural experimentation and event analysis. Large and seemingly exogenous shocks to monetary policy have no measurable effect on the natural rate of interest according to nonparametric and parametric tests. Therefore Wicksell's Classical Dichotomy is empirically valid.

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