Abstract
In this paper we study the drivers of global interest rate. Global interest rate is defined as a principal component for the largest developed and developing economies’ discount rates (the US, Japan, China, Euro area and India). A structural global factor-augmented error correction model is estimated. A structural change in the global macroeconomic relationships is found over 2008:09-2008:12, but not pre or post this GFC period. Results indicate that around 46% of movement in central bank interest rates is attributed to changes in global monetary aggregates (15%), oil prices (13%), global output (11%) and global prices (7%). Increases in global interest rates are associated with reductions in global prices and oil prices, increases in trade-weighted value of the US dollar, and eventually to reduce global output. Increases in oil prices are linked with increase in global inflation and global output leading to global interest rate tightening indicated by increases in central bank overnight lending rates.
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