Macro-driven ultimate forward rates and long-term interest rates

The fact that long term interest rates have been higher on average than short rates in the twentieth century has often been interpreted in the term structure literature as evidence of the existence of positive or term premiums. The purpose of this paper is to point out that an average differential between long and short rates does not necessarily represent a differential between returns realized by holders of long versus short term bonds. In particular, it is shown that if short term rates are positively autocorrelated, interest rate differentials overstate differentials in realized rates of return. We conclude that liquidity or term premiums properly estimated from the Durand yield curve data are not consistent with the liquidity preference theory. LONG TERM INTEREST RATES have been higher on average than short term rates during the twentieth century. The average differential over the period 1900-1958 between long term interest rates and spot one year rates in the Durand yield curve data increases monotonically with term to about half a percentage point at forty years. The interpretation given to these differentials in the term structure literature is that they are the additional rate of return earned on average by capital invested in long term bonds. The purpose of this paper is to point out that an average differential between long and short term interest rates does not necessarily represent a differential between realized rates of return. This is because the realized increment to capital invested in a sequence of short term bonds depends on the ex post product of uncertain future spot rates. The expected value of this ex post product will in general differ from the product of expected future spot rates. We show that if short term rates are positively autocorrelated, the interest rate differentials overstate differentials in realized rates of return. We shall refer to differentials in realized rates of return as term premiums. The proper interpretation of interest rate differentials is important to the assessment of the evidence for various theories of the term structure. The liquidity preference theory of J. R. Hicks [4, pp. 144-147] predicts that a term premium will be earned by capital invested in long term bonds because their holders require compensation for risk of capital fluctuation. Forward interest rates will exceed one period spot rates on average by the amount of premium which rises monotonically with horizon. The positive and monotonic average differentials between forward and spot one year rates in the Durand data have been

The relationship between long-term and short-term interest rates is crucial for macroeconomic policy evaluation. Since the short-term interest rate is the opportunity cost of holding money, it is widely believed that the Federal Reserve has more direct control over short-term than over long-term interest rates in the United States. Yet if capital is costly to adjust or takes time to place into use, investment decisions may depend on long-term interest rates. The term structure of interest rates thus appears central to the monetary transmission mechanism. Unfortunately, the determinants of the term structure remain poorly understood. This paper uses data from the United States, Canada, and the United Kingdom, and Germany to examine various hypotheses regarding the term structure. My goal is to see whether the experiences of these four countries since 1960 can help provide a general explanation of the term structure. In the United States many observers believe the large variations in the long-term interest rate since 1979 are not adequately explained by movements in short-term interest rates. Of particular interest is whether the experience of the United States in these and earlier years merely reflects an unusual historical episode. If it does, it would be inappropriate to draw any general conclusions from this experience or to extrapolate this experience into the future. This study is in part motivated by apparent differences between recent experience in the United States and experience elsewhere. In 1985, the rate on long-term government bonds in the United States exceeded the rate on three-month Treasury bills by more than 300 basis points. By contrast, the long-term interest rate in the United Kingdom was more than 100 basis points below the short-term interest rate. Interpreting such divergent national experiences is the primary purpose of studying the term structure more generally.

Many proposals are made to extend Taylor rule by including in the optimal reaction function other variables than those originally introduced by Taylor (Discretion versus policy rules in practice, Carnegie-Rochester Conference Series on Public Policy, 1993). The empirical studies point out the importance of long-term interest rates to explain and to forecast the behaviour of the monetary policy control variable. In particular, the positive shocks on long-term interest rates seem to induce a restrictive monetary policy and this finding is explained through the hypothesis that these shocks include the rational expectations on the future inflation rate. McCallum (Federal Reserve of Richmond Economic Quarterly 91(4), 1---21, 2005) assumes a positive relation between long-term and short-term interest rates to explain the inconsistency of US data with the expectations theory of the interest rate term structure. In this paper a new theoretical model is developed and analysed where the model of Clarida et al. (Journal of Economic Literature, 37(4), 1661---1707, 1999) is extended in the above outline of the term structure rational expectations hypothesis and also the dynamics of the nominal long-term interest rate as well as the dynamics of real exchange rate are involved. The optimal reaction function is provided by the algorithm described in Dennis (Journal of Economic Dynamics & Control, 28, 1635---1660, 2005) and the empirical impulse response function is obtained by estimating a VAR model. In spite of the empirical finding, the results obtained from the proposed theoretical model show that the optimal response to a positive shock in long-term interest rate is a reduction in the short-term and an economic rationale of this finding is suggested.

This study attempted to examine the volatility spillover between the sovereign bond returns of South Africa and Ghana and the emerging market bond return, USA stock market return and the world long term interest rate using weekly data in the period of 2014–2022. The research used dynamic and constant conditional correlation generalized auto-regressive conditional Heteroskedasticsticity models. The result showed that the volatility of long-term world bond interest rate and USA stock market return affected the Ghana sovereign bond return positively and negatively, respectively. Similarly, the volatility of emerging market bond return and long-term world interest rate affected the South African sovereign bond return positively and negatively, respectively. Thus, policy intervention is needed to contain the negative impact of stock market and long-term world interest rates.

Have US external imbalances been determined at home or abroad?

MANY HAVE NOTED THAT we appear to be living in an era of low long-term interest rates and high asset prices. Although long-term rates have been increasing in the last few years, rates so far in the twenty-first century are still commonly described as low, in both nominal and real terms, compared with historical averages or with a decade or two ago. Meanwhile stock prices, home prices, commercial real estate prices, land prices, and even oil and other commodity prices are said to be very high.1 The two phenomena appear to be connected: elementary finance theory states that if the long-term real interest rate is low, the rate of discount used to determine present values will also be low, and hence present values should be high. This pair of phe-nomena, connected through the present-value relation, is often described as one of the most powerful forces operating on the world economy today. In this paper I will critique this common view about interest rates and asset prices. I will question the accuracy and robustness of the “low long rates, high asset prices ” description of the world. I will also evaluate a pop-ular interpretation of this situation, namely, that it is due to a worldwide regime of easy money. I will argue instead that changes in both long-term interest rates and asset prices seem to have been tied up with important changes in the public’s ways of thinking about the economy. Rational expec-tations theorists like to assume that everyone agrees on the model of the economy, which never changes, and that only some truly exogenous factor,

No abstract available.

An Empirical Analysis of Long-Term Brazilian Interest Rates

The study investigated the existence of volatility and spillover effects between sovereign bond returns of South Africa and Ethiopia and the world’s long-term interest rate using multivariate generalized autoregressive conditional heteroskedasticity model. The results showed that volatility from the long-term world interest rate negatively affects the Ethiopian sovereign bond market. The results also showed a one-way spillover from South Africa's market to the U.S. long-term market, then from the U.S. to Ethiopia's market, and further from Ethiopia's to South Africa's market. However, no bidirectional spillover was observed within these markets. Besides, both African markets display high volatility persistence. Besides, the markets have a weak or insignificant correlation with the world’s long-term interest rate. Volatility in the markets is significantly affected by their respective past shocks or volatilities. Finally, it has forwarded policy inputs that should be tailored to the specific economic and financial context of each country.

Long-term interest rates, risk premia and unconventional monetary policy

If interest rates are considered to be integrated of order one (I(1)) uncovered interest rate parity (UIP) implies that domestic and foreign nominal interest rates should be integrated with cointegrating vector (1,-1). On the other hand, if the expectations hypothesis of the term structure (EHT) is true another equilibrium condition can be derived, namely that domestic short- and long- term interest rates should cointegrate with the vector (1,-1). Thus UIP and EHT imply that three cointegrating vectors should exist in the four dimensional system of short- and long-run domestic and foreign interest rates. These hypotheses are tested with monthly observations of short- and long-term European and US interest rates for the period 1994(1) to 2001(12). It is found that only one cointegrating relation exists between these four interest rates. It is a linear combination between the spread in Euroland and the spread in the US. A vector error correction model for the spreads gives further insights into the dynamic relations between the interest rates in the US and Euroland.KeywordsUncovered interest rate parityexpectations hypothesiscointegrationvector error correction modelling

This paper documents some features of recent trends in bond yields and discusses the drivers of these trends. This includes a discussion of the relationship between fiscal balances and interest rates -- with a summary of key empirical results from the literature provided in the Appendix. The main points to emerge from this analysis are as follows. First, cyclical and portfolio-allocation factors seem to have been the main driving forces behind the decline in long-term real interest rates over 2000-2003. However, in some European countries, declining (inflation, exchange-rate, and sovereign) risk premia suggest that the equilibrium real interest rate may now be somewhat lower. Second, the weight of recent evidence suggests a causal relationship from fiscal positions to long-term interest rates, at least for the United States. Thus, the actual and projected deterioration in US fiscal positions might have contributed to the recent rise in bond yields, although part of the ...

Rental rate has been suggested as a better alternative to replace the interest rate in Islamic home financing. However, the suggested alternative has to be free from the influence of any form of interest rate. This paper examines the long-run influence of macroeconomic variables on the rental rate in the United Kingdom housing market. The aim is to investigate whether the rental rate is free from the influence of both long-term and short-term interest rates in order to substitute the interest rate in Islamic home financing. The study employs Autoregressive distributed lags (ARDL) model to empirically estimate a long-run relationship between the rental rate and some selected macroeconomic variables. Using the United Kingdom housing market data from the first quarter of 1990 to the last quarter of 2016. The results show that rental rate is free from the influence of both short-term and long-term interest rate. Hence it could be recommended as an alternative to interest for Islamic home financing. The results further show that GDP, inflation rate, and share price positively influence rental rate.

We examine the accuracy of Blue Chip forecasts of short- and long-term interest rates and country risk premiums for the Eurozone and six other industrial countries for 1999–2008. In so doing, we utilize comparable random walk forecasts as benchmarks. Consistent with the efficient market hypothesis, the long-term interest rate forecasts fail to outperform the random walk. Our findings on the accuracy of short-term interest rate forecasts are, however, mixed. Further results reveal that Blue Chip is more (less) accurate in predicting country risk premiums associated with short-term (long-term) interest rates. Such evidence is reasonable since the short-term country risk premiums contain only the perceived default risk, while the long-term risk premiums, in addition, can contain the perceived inflation and exchange rate differentials.

This paper empirically models the dynamics of Brazilian government bond (BGB) yields based on monthly macroeconomic data, in the context of the evolution of the key macroeconomic variables in Brazil. The results show that the current short-term interest rate has a decisive influence on the long-term interest rate on BGBs, after controlling for various key macroeconomic variables, such as inflation and industrial production. These findings support John Maynard Keynes’s claim that the central bank’s actions influence the long-term interest rate on government bonds mainly through the current short-term interest rate. These findings have important policy implications for Brazil. This paper relates the findings of the estimated models to ongoing debates in fiscal and monetary policies.