International Evidence on the Interest Rate Effect in Dynamic IS Curves

ABSTRACT

A number of studies have found little evidence of the effect of the interest rate in dynamic IS curves. We show that this is due to de-trending. The interest rate has a weak effect on the output gap even when controlling for wealth effects. However, when the IS curve is formulated in an error-correction form, we find a significant interest rate effect. Furthermore, we find that the nominal interest rate explains output dynamics better. Lastly, there are significant effects of long-term interest rates in emerging markets, which may justify the use of yield curve control policies in these economies.

KEYWORDS:

• Output gap
• interest rate
• IS curve
• backward looking

JEL:

• C12
• C2
• E1

Disclosure statement

No potential conflict of interest was reported by the author(s).

Supplementary material

Supplemental data for this article can be accessed online at https://doi.org/10.1080/1540496X.2023.2293973.