Cash Rate Research Articles

The target cash rate and its impact on investment asset returns in Australia

This article examines the relationship between asset returns and changes in the announced target cash rate of the Reserve Bank of Australia during the period from September 1990 to June 2000. Using a two stage least squares model adapted from Lowe (1995) the analysis found that there is an impact on property returns during the month of the announced change in the cash rate. This finding is not supported for other sub-indices on the Australian stock exchange, apart from Tourism and Leisure where there is also an identifiable impact.

An Exploration of Measures to Assess a Bank's Credit Loss Experience

Data related to the credit loss experience (CLE) of financial institutions are widely used for a variety of research, yet the literature typically omits a discussion on the construction and selection of suitable CLE proxies. Based on a comprehensive dataset of potential CLE proxies retrieved from original financial reports of 32 Australasian banks (1980 - 2005), this article analyses properties and interactions of potential proxies through time. It is found that some commonly used proxies correlate rather poorly and bad debt provisioning is only partially matched by subsequent write-offs. The results highlight the need for caution in the use of historical credit loss data proxies commonly used by researchers. ABSTRACT We evaluate the extent of real interest rate interdependence among three month treasury bill rates of the G7. Monthly data over the period 1970(1) to 2003(12) is subjected to recursive estimation of a cointegrating equation. The evidence suggests a high degree of interdependence between the G7 interest rates with the degree of integration increasing over the sample period. Tests for parameter constancy highlight the disruptive effects of the first oil price shock although the impacts on financial markets of the September 11 and the attack occurrence of the Asian crisis have limited impacts. The evidence for the presence of a leading nation among the G7 is inconclusive although Germany and the US are the prime leadership contenders. The high degree of interdependence between the G7 financial markets suggests that capital between the G7 is highly mobile. ABSTRACT A lump sum conversion strategy - 'ORARIS' (Optimal Risk-Averse Retirement Income Stream) - which effectively involves splitting a retirement lump sum into two parts, one part for purchase of a guaranteed term-certain indexed annuity at a yield at or about the central bank's cash rate, the other for 'set and forget' investment in a national stockmarket index fund over the guaranteed income years, is shown to be optimal under the classic mean-variance criterion of Markowitz portfolio theory. The scheme depends upon the expectation of redeeming the entire original capital in real terms in the

Monetary Policy, Open Market Operations and New Zealand Interest-Rate and Exchange-Rate Markets

This paper examines the impact of the Reserve Bank of New Zealand's open market operations (OMOs) and monetary policy on interest rates and foreign exchange markets. We focus on the effect of OMOs and cash rate target announcements in two distinctive monetary policy regimes with different degrees of policy transparency. Our empirical results suggest that the OMOs conducted by the central bank have significant contemporaneous impacts on returns volatility of short-and long-term interest rate markets but not on the New Zealand dollar exchange rate market. Strong OMO effects are observed for all five markets during the MCI period. Our findings suggest that, although the role of the OMOs decreases as monetary policy transparency increases, the OMOs still convey important information that shapes market expectations and redirects market participants' expectations of future monetary policy movements. OMOs therefore impact on mean returns and return volatility of New Zealand financial markets.

Instrument Insufficiency and Economic Stabilisation

Recently concerns have been raised in New Zealand about the effectiveness of monetary policy in controlling inflation while avoiding damage to the economy from high exchange rates. This review examines the basis for concern and identifies the problem as a failure in the primary instrument, namely the Reserve Bank's official cash rate, to adequately impact further along the term structure curve, which has become the more sensitive area for aggregate demand. Direct control over expenditure is therefore weak, and too much leeway is left to the housing and other asset markets to sustain demand in the economy. Globalisation of credit availability and financial technology have helped to blunt the policy instrument in this respect, shifting the adjustment burden on to the exchange rate. Deft management of interest and currency expectations can help, but the problem may require closer coordination and cooperation between monetary and fiscal policy, restoring a stabilisation role for the latter.

MODELLING DEMAND FOR BROAD MONEY IN AUSTRALIA*

The existence of a valid long-run money demand function is still important for the conduct of monetary policy. It is argued that previous work on the demand for money in Australia has not been very satisfactory in a number of ways. This paper examines the long- and short-run determinants of the demand for broad money employing the Johansen cointegration technique. Using quarterly data for the period 1976:3–2002:2, this paper finds, inter alia, that the demand for broad money is cointegrated with real income, the rate of return on 10-year Treasury bonds, the cash rate and inflation. It appears that a disequilibrium in the demand for money can affect the efficacy of interest rate policy in the long run via its impact on future output growth and output gap.

Estimates of time‐varying term premia for New Zealand and Australia

Forward rates in the money market are systematically higher than realised spot rates, reflecting an unobservable term premium. This paper uses a Kalman filter specification to produce time‐varying estimates of the term premia in New Zealand and Australia. Three time series specifications are used to examine the properties of the premia, such as the average size, volatility, and the degree of mean reversion. Compared to the constant term premia estimates, the time‐varying estimates explain significantly more of the difference between forward and spot rates. The results suggest that the premium in New Zealand is slowly mean‐reverting, while the Australian premium reverts quickly to the mean. It is not clear whether the method of monetary policy implementation affects the term premium, although in New Zealand the premium has been smaller and less variable since the introduction of the Official Cash Rate in March 1999. A related finding is that the size of the term premium is correlated with the volatility of short‐term rates.

The stationarity of Australian real interest rates with and without structural breaks

The Australian cash rate is generally unstable, while surveyed expected inflation and the 90 day bank bill rate are stationary subject to breaks. Real bond rates (2, 5, 10 years) are stationary in levels. Policy and market implications are drawn.

Extracting Expectations of New Zealand's Official Cash Rate from the Bank-Risk Yield Curve

The hypothesis that a forward term-premium (FTP) exists between forward 1-day rates calculated from the New Zealand bank-risk yield curve and the corresponding ex-post Official Cash Rate (OCR) is tested by applying a single equation method for a cointegrated system to daily data from March 1999 to December 2001. The results indicate that the FTP is statistically significant for all forward horizons tested. The results also indicate that the estimates of the FTP appear to be an increasing function of the forward horizon, and the FTP may be tentatively represented as a simple monotonically-increasing analytical function. The model may be used in reverse to imply current ex-ante expectations of the OCR.

Analysis of divisional profitability using the residual income profile: a note on cash flows and rates of growth

The present note expands on the (Frigo and Ciecka (1995)) residual income profile in order to analyze the relationship between residual income (RI), return on investment (ROI) and cash flows. The results indicate that in addition to the question of whether RI and ROI are useful in divisional performance evaluation, both measures also have an important role to play as a means of approximating actual cash flow. © 1998 John Wiley & Sons, Ltd.

A New Rule for Monetary Policy

DISAGREEMENTS tred them. on Today, the relative central about importance bankers the conduct everywhere of its of goals monetary treat and inflation policy the best have control means traditionally of as achieving the main cenDISAGREEMENTS tred on the relative importance of its goals and the best means of achieving them. Today, c ntral bankers eve ywhere treat infla ion contr l a the main objective of monetary policy, but retain considerable discretionary powers while operating with varying degrees of independence from governments. But do central banks know more about an economy's fundamentals than the financial markets, which act, direcdy or indirecdy, on behalf of all agents in the economy? Under present arrangements, the interest rate structure reflects the markets' best estimate of where the central bank will set cash rates. Interest rates vary considerably in response to the markets' continuous second guessing of discretionary changes. Discretionary interest-rate setting by the central bank thus contributes to longer-term interest rates being persistently higher than necessary, with adverse consequences for investment and long-term economic growth. If monetary policy were to become rulebased, however, market uncertainty about the future direction of the cash rate would be eliminated, and long-term interest rates would be lower than otherwise. In this article, a new rule for monetary policy is outlined, involving the automatic setting of interest rates by the central bank. The proposed rule is based on a reinterpretation of the so-called expectations hypothesis of the term structure of interest rates. Its rationale is to minimise the level of discretion-induced economic uncertainty by effectively allowing financial markets to set all interest rates. Over time, the cash rate automatically set by the authorities in accordance with the rule would reflect, not the central bank's own discretionary view of its appropriate level, but the collective view of the financial markets based on their information set of the economy's fundamentals.

The information content of the yield curve in Australia

This paper examines the expectation theory of the term structure of interest rates in Australia. Bivariate vector autoregressive (VAR) analysis indicates that the spreads between the long-term and the short-term rates are informative about changes in short rates. Moreover, the spread between the short-term rate and the official cash rate Granger-causes changes in the cash rate. These findings imply that the monetary authorities could influence long-term rates by intervening on the official cash rate. The results of the efficient market restrictions tests are sensitive to the information set and the frequency of the data used.

The Transmission of Monetary Policy: The Relationship Between Overnight Cash Rates*

This paper utilizes daily data from the period of the ‘clean’ float of the Australian dollar to consider the relationship between two key Australian short‐term interest rates: the official and the unofficial overnight cash rates. There is a stable long‐run differential of I per cent between the two rates and a short‐run dynamic policy reaction function is found which indicates that the official rate reacted to the size of the past interest rate differential.