Changes In Real Interest Rates Research Articles

Indicators of Currency Crisis: Empirical Analysis of Some Emerging and Transition Economies

This paper focuses on the measurement of a contemporaneous currency crisis. The analysis covers 14 or transforming economies that experienced episodes of currency crises over the last decade. It adds to well-known examples relatively littleknown evidence on the crisis depth in some of the CIS countries. Following the Eichengreen, Rose, and Wyplosz (1994) definition of a currency crisis, the emphasis is primarily put on the examination of changes in relative reserves, exchange rates, and real interest rates during periods of exchange rate pressure. Other measures of the depth of a currency crisis as well as measures of external vulnerability are also discussed. The findings support the adequacy of the Eichengreen, Rose, and Wyplosz (1994) definition in analyzing crisis developments in emerging economies.

Commodity prices, interest rates and the dollar

This paper sheds light on recent fluctuations in commodity prices. We investigate whether a decline in real interest rates and the US dollar contributes to higher commodity prices, and whether commodity prices display overshooting behavior in response to changes in real interest rates. We analyze the behavior of real prices of crude oil, food, metals and industrial raw materials. The analysis is based on structural VAR models estimated on quarterly data over the period 1990q1–2007q4. Our results suggest that commodity prices increase significantly in response to reductions in real interest rates. Moreover, oil prices and prices of industrial raw materials tend to display overshooting behavior in response to such interest rate changes. The evidence also suggests that a weaker dollar leads to higher commodity prices. Shocks to interest rates and the dollar are found to account for substantial shares of fluctuations in commodity prices.

Have Real Interest Rates Really Fallen that Much in Spain?

This paper analyses the behaviour of real interest rates in the Spanish economy over the last 15 years. Since inflation-indexed-bonds are not available, changes in implicit real interest rates are estimated using several approaches suggested by macroeconomic and financial theory. In particular, we employ equilibrium conditions of a representative agent under several specifications of preferences. Moreover, we exploit no-arbitrage conditions in securities markets. The evidence we report indicates that inflation uncertainty could account for a notable part of the observed decrease in nominal rates. Consequently, the actual real cost of financing might have decreased significantly less than what the course of ex-post real rates would suggest.

Capital Stock and Unemployment: Searching for the Missing Link

The purpose of this paper is to examine the proposition that capital stock relative to aggregate output has been an important variable in the determination of the U.S. NAIRU (Non-Accelerating Inflation Rate of Unemployment) over the last four decades. We present new empirical evidence, obtained from the application of the cointegrated VAR methodology to U.S. time-series data, that lends strong support to the claim that the aggregate capital-output ratio, the real price of imports, and aggregate capacity utilization were determinants of the NAIRU in the period considered. The same evidence also shows that technical progress and changes in long-term unemployment did not affect the NAIRU. We believe this evidence suggests that, insofar as the aggregate capital-output ratio is affected by changes in real interest rates, the stance of monetary policy is one determinant of the NAIRU.

Empirical Characteristics of Money in Nigeria

There is a marked tendency to treat outside money, inside money and quasi money alike as if they can be explained by the transactions money demand function in extant empirical studies of money demand in Nigeria. This paper examines the appropriateness or otherwise of applying the transactions demand framework across the aggregates available for Nigeria. The five aggregates that have been modeled in extant literature are currency outside banks (COB), demand deposits (DD), narrow money (M1=COB+DD), Quasi Money (QM), and Broad Money (M2), which is the sum of M1 and QM. A sixth aggregate that has not been modeled is the monetary base (MB). The objective is to classify the six aggregates into those that can rightfully be modeled within the transactions' demand framework and those that are more likely to be appropriately modeled within rival approaches such as the Granger-causality or the money multiplier frameworks. We found that while the relationship between inside money (demand deposits) and real activity in Nigeria can be captured by transactions' demand function, outside money aggregates like currency outside bank (COB) and monetary base (MB) are not determined by real activity and interest rates in Nigeria. The significant differences in the relations of outside and inside money aggregates to real activity in Nigeria is that inside money is endogenous to changes in real activity and interest rates, while outside money is not. While the two components of narrow money are related to real economic activity in qualitatively and quantitatively different ways, demand deposits seem to dominate currency outside banks once both are added to define M1. Quasi-money could not be explained by a transactions demand function. Broad money (M2) could similarly not be explained by a transactions demand function.

Do foreign bank operations provide a stabilizing influence in Korea?

We examine data (1994–2001) to determine if foreign banks’ behavior differed from domestic banks and if foreign banks helped to stabilize Korean markets. Foreign banks’ financial ratios differed from Korean banks with two notable exceptions: provisions for loan losses and loan growth. Before the Asian financial crisis, all banks’ loans generally did not respond to Korean market conditions. Post crisis, foreign banks reduced total lending. Foreign banks increased and Korean banks decreased won-denominated loans when Korean economic conditions improved after the crisis. Finally, foreign banks’ lending reacted to changes in home-country GDP growth and real interest rates.

A Note on Deficit, Implicit Debt, and Interest Rates

This short note revisits the long-standing issue of the relationship between government borrowings and interest rates using vector autoregression (VAR) models. In particular, we consider the dynamic impacts of both official deficit and implicit debt on the interest rates. Two measures of unfunded Social Security obligations (implicit debt) are examined. The recently developed generalized forecast error variance decompositions, which are invariant to the ordering of variables in VARs, are adopted. We find that temporary shocks to the official deficit do not cause real interest rate changes in the short term but do cause moderate changes in the long term. They have significant impact on nominal interest rates in both short and long horizons. The implicit debt also appears to have some moderate influence on real interest rates at long horizons.

A Note on Deficit, Implicit Debt, and Interest Rates

This short note revisits the long‐standing issue of the relationship between government borrowings and interest rates using vector autoregression (VAR) models. In particular, we consider the dynamic impacts of both official deficit and implicit debt on the interest rates. Two measures of unfunded Social Security obligations (implicit debt) are examined. The recently developed generalized forecast error variance decompositions, which are invariant to the ordering of variables in VARs, are adopted. We find that temporary shocks to the official deficit do not cause real interest rate changes in the short term but do cause moderate changes in the long term. They have significant impact on nominal interest rates in both short and long horizons. The implicit debt also appears to have some moderate influence on real interest rates at long horizons.

Tax Policy and Irreversible Investment

We examine the impact of tax policy uncertainty on the irreversible investment decisions of a monopolistically competitive firm. We consider the impact of tax policy in terms of the investment tax credit (ITC) as well as the stochastic tax wedge which determines the after-tax costs of investing. We show that (i) temporary tax incentives have a greater stimulative impact on investment; (ii) greater policy volatility results in greater variability of investment; (iii) a stochastically larger future tax policy lowers current investment; and (iv) greater variability of tax policy around a constant mean leads to lower investment. We examine changes in the average levels of investment and its variability over short- and long-run horizons. We consider a general 3-state process, a log-normal process, and a Poisson process. We carry out an extensive sensitivity analysis that allows us to examine the impact of changes in real interest rates, and changes in the elasticity of demand facing firms.

Labor's Capital, Business Confidence, and the Market for Loanable Funds

The market for loanable funds provides a useful framework for determining changes in investment and interest rates. In the United States, a significant source of supply originates from labor in the form of pension assets. However, despite the increased contribution by labor to the supply curve over the past several decades, levels of investment have remained less than robust. Here, we highlight the changes in the demand curve for loanable funds in order to explain the empirical trends. Data series provided by the Conference Board capture the confidence of U.S. business and thus provide a gauge of Keynes' animal spirits - an essential factor in the demand curve shifts. Correlation of the data series with both quarterly changes in real interest rates and quarterly changes in payroll employment offers documentation for these macroeconomic claims.

Monetary transmission mechanism in Turkey under the monetary conditions index: an alternative policy rule

This study analyses monetary transmission mechanism in Turkey using a small structural macroeconomic model. The core equations of the model consist of aggregate demand, wage-price setting, uncovered interest rate parity, foreign sector and a monetary policy rule. The aim of the paper is to analyse the disinflation path, the output gap, the output level, the exchange rate and the interest rate, and also the output–inflation variance frontier of the economy under various scenarios. The first scenario assumes that a standard Taylor rule is implemented as the policy rule. In the alternative scenario, instead of the standard Taylor rule, the MCI, Monetary Conditions Index – combination of the changes in the short-term real interest rate and in the real effective exchange rate in a single variable – is used as a policy instrument. The results indicate that the economy stabilizes much more quickly and shows significantly less volatility under this new setting. Therefore, the paper concludes that the policymakers should consider using MCI as an instrument when conducting monetary policy.

Stock Market Sensitivity to Interest Rates and Inflation

Knowledge of the interest rate sensitivity of stocks is important in many areas of investment and finance. This paper makes three contributions to the existing literature: (a) it provides estimates of stock sensitivity to changes in nominal and real interest rates and expected inflation (b) it provides estimates of the degree of indexation of future growth expectations to changes in nominal and real interest rates and expected inflation and (c) examines whether government regulation, cyclicality of future cash flows and growth versus value characteristics of stocks can explain the differences in interest rate sensitivities across stocks.

Long-Run Information Diffusion Processes in the Perth Housing Market: 1988–2000

In the period since the influential studies by Case and Shiller (1989, 1990), it has been established that housing markets are characterised by information diffusion patterns determined by informational inefficiencies. In Australia, little work has been completed on the long-term patterns of these inefficiencies. This paper examines a rich data set of transactions for the Perth housing market in the period 1988-2000. The results confirm some significant long-term patterns for real house price changes and some close relationships between these patterns and changes in real interest rates.

Estimation of the Rental Adjustment Process

Rental adjustment equations have been estimated for a quarter century. In the United States, models have used the deviation of the actual vacancy rate from the natural rate as the main explanatory variable, while in the United Kingdom, drivers of the demand for space have dominated the estimation. The recent papers of Hendershott (1996) and Hendershott, Lizieri and Matysiak (HLM 1999) fall into the former category. We reestimate these equations using alternative formulations and present evidence that changes in real interest rates were not capitalized into Sydney and London real land prices. We then derive a model incorporating supply and demand factors within an Error Correction framework and show how the U.S. and U.K. traditions are special cases of this more general formulation. We next estimate a two‐equation variant with a separate vacancy rate equation using data from the City of London office market. This model allows calculation of the underlying price (rent) and income (employment) elasticities and explains the data marginally better than the HLM model. Importantly, our model passes standard modern econometric requirements for unit roots and cointegration.

Openness and Equilibrium Determinacy Under Interest Rate Rules

This paper shows that the conditions under which inflation-targeting interest rate rules lead to equilibrium uniqueness in a small open economy in general differ from those in a closed economy. As the monetary authority adjusts nominal interest rates in response to inflation, the real interest rate changes. The overall effect of this change on aggregate demand has important implications for equilibrium determinacy. In an open economy, an increase in the real interest rate is transmitted to aggregate demand through an intertemporal substitution effect, as in a closed economy, but also through a terms of trade effect that is absent in the closed economy. These effects move aggregate demand in opposite directions. We find that, in a broad class of models, the conditions for local equilibrium uniqueness depend crucially on the degree of openness to international trade. Openness matters not only quantitatively, but also qualitatively. JEL Classification: E52, E58, F41

An Empirical Analysis of the Effect of Changes in Interest Rates on Accounting Rates of Return, Growth, and Equity Values

This paper examines whether the documented negative correlation between changes in interest rates and stock returns is also observed in the fundamentals on which equity values are based. The negative correlation is often attributed to changes in the discount rate, a denominator effect in a valuation model. However, there may also be a numerator effect on the expected payoffs that are discounted, and it is this effect that the paper examines. The paper documents the effect of changes in interest rates on accounting profitability and asset growth that are tied to expected dividends and value in the residual earnings valuation model. The effects of changes in both real and nominal interest rates are investigated so that the effects of changes in expected inflation (that has been the focus of much of the research on interest rates and stock returns) are isolated. Accordingly, the paper evaluates the Modigliani and Cohn conjecture that investors do not understand the effect of changes in expected inflation on firms. The results show that both real and nominal rates are positively related to subsequent profitability and growth, at least in the near term. So, increases in interest rates are followed by higher profitability and growth. However, the resultant increase in earnings is typically not large enough to cover the increase in the required return from the increase in the interest rate. So the overall effect on equity value is negative, consistent with the results of the research on interest rates and stock returns.

Real Interest Rate Parity under Regime Shifts and Implications for Monetary Policy

We use recently developed cointegration tests that determine the regime shift endogenously to test for bilateral real interest rate convergence (real interest rate parity) in the G7 against the USA in the 1974–95 period. In contrast with previous studies that employed classical regression analysis and standard cointegration tests, our innovative approach provides strong evidence in favour of bilateral real interest rate convergence between the USA and several countries in our sample, in particular for short-term real interest rates. Our results highlight the fact that for a number of countries in our sample (Canada and the UK) monetary policy can act as a stabilization policy tool through its effect on domestic long-term real interest rates, while for others (France and Germany) long-term real interest rate changes are influenced by the US monetary policy stance.

The Relationship between Real Wages and Output: Evidence from Pakistan

Information on wage levels is essential in evaluating the living standards and conditions of work and life of the workers. Since nominal wage fails to explain the purchasing power of employees, real wage is considered as a major indicator of employees purchasing power and can be used as proxy for their level of income. Any fluctuations in the real wage rate have a significant impact on poverty and the distribution of income. When used in relation with other economic variables, for instance employment or output they are valuable indicators in the analysis of business cycles. There has been a long debate regarding the relationship between real wages and the employment (output). Despite the apparent simplicity, the relationship between real wages and output has remained deceptive both theoretically and empirically. Keynes (1936) viewed cyclical movements in employment along a stable labour demand schedule thus indicating counter cyclical real wages. His deduction is in line with sticky wages and sticky expectations, which augments models like Phillips curve. In these models real wages behaved as counter-cyclical as nominal wages are slow to adjust during recession (decrease in aggregate demand and associated slowdown in price growth). Stickiness of wages or expectations shifts the labour supply over the business cycles [Abraham and Haltiwanger (1995)]. Barro (1990) and Christiano and Eichenbaum (1992) have associated these labour supply shifts with intertemporal labour-leisure substitution. This in response to temporary changes in real interest rates (fiscal policy shocks) could yield counter-cyclical real wages. However, Long and Plosser (1983) and Kydland and Prescott (1982) while studying the real business cycle models highlight on the technology shocks which leads to pro-cyclical real wages.

Inflation targets and the yield curve: New Zealand and Australia versus the US

This study considers whether the slope of the yield curve for New Zealand contains useful economic information. In order to provide some perspective, the present study also contrasts the New Zealand experience with evidence based on US and Australian data. The principal findings of this study are as follows: (1) At short horizons, typically 2 years or less, the term structure for New Zealand behaves as in the expectations hypothesis of the term structure. (2) Nevertheless, there are departures from the expectations hypothesis, especially in the period when inflation objectives in New Zealand were on a declining path. Moreover, the policies of the US had a critically important impact around 1993–1994. (3) Some evidence was found of an effect from the spread to future inflation but only when the headline CPI is used to measure inflation; the links disappear entirely once CPI ex-credit costs are employed. The study argues that such results are consistent with a credible inflation targeting regime, so that the term structure serves possibly to signal changes in real interest rates rather than inflation in New Zealand. (4) There is good evidence that the spread helps predict future output in New Zealand, although the effect seems to dissipate after 1 year. Once we distinguish between periods of positive versus negative growth rates in real gross domestic product (GDP), the spread influences output up to 2 years into the future. Also, when output growth is measured asymmetrically, rising inflation expectations depress output growth. Copyright © 2000 John Wiley & Sons, Ltd.

Interest rates, risk, and imperfect markets: puzzles and policies

Traditional theory emphasizes the key role that monetary policy can play through the manipulation of interest rates. But there are several puzzles that cannot be reconciled with standard models. These include: the apparent constancy in interest rates over extended periods, and changes at other times which appear unrelated to changes in technology and demography; the cyclical pattern of movements in real interest rates; the impact of nominal not real interest-rate changes on real variables; and the cyclical pattern of movements in interest-rate spreads. This paper reaches beyond the standard competitive equilibrium, perfect information, model of credit markets towards imperfect information models, particularly those that focus on the determinants of bank behaviour. Of the standard models, the money demand model is most deficient in understanding these puzzles. The loanable funds theory and a generalized version of real productivity theory can be reconciled with imperfect information, and markets and the consequent credit and equity rationing regimes help to explain the puzzles. Specifically, banks may be insensitive to changes in monetary stance owing to risk aversion. There are strong policy implications; it is argued, for instance, that in East Asia raising interest rates exacerbated economic decline and, rather than contributing to exchange-rate stability, may have induced capital flight as default risk increased, lowering risk-adjusted expected returns.