Score contribution per author:
α: calibrated so average coauthorship-adjusted count equals average raw count
We propose a novel explanation for persistent movements in the natural rate of interest, or r-star, based on a model of two-sided learning between the central bank and the private sector. Each side has some information about r-star fundamentals and also learns from observing output, inflation and interest rates. When both sides fail to recognise that their actions influence the other’s beliefs, a “hall-of-mirrors” effect arises that causes persistent shifts in r-star in response to cyclical shocks. The model can explain the post-2008 decline in r-star without changes in long-run fundamentals, as well as the excess sensitivity of long-term yields to monetary policy surprises and the underreaction of interest rate forecasts. Aggressive policy easing designed to counter a recession can inadvertently lower r-star and endogenously narrow policy space.