Changes In Real Interest Rates Research Articles

Causal relations among stock returns and macroeconomic variables in a small, open economy

We investigate to what extent important results on relations among stock returns and macroeconomic factors from major markets are valid in a small, open economy by utilizing the multivariate vector autoregressive (VAR) approach on Norwegian data. Unlike many previous studies, which use a different methodology on other European markets, we establish several significant links. Consistent with US and Japanese findings, real interest rate changes affect both stock returns and inflation, and the stock market responds accurately to oil price changes. On the other hand, the stock market shows a delayed response to changes in domestic real activity.

Exchange risk and the supply-side effects of real interest rate changes

This paper studies the supply-side effects of real interest rate changes in a small open economy. Exchange risk premia in the foreign exchange markets allow domestic monetary conditions to have an impact on domestic real interest rates, driving them apart from those of the rest of the world. Under these circumstances, a reduction of domestic real rates relative to foreign rates brings significant benefits in terms of increased real output and employment and an improvement in the current account. Monetary policy is non-neutral, and the capital outflow induced by lower domestic real rates actually has a beneficial impact by improving the country's international credit position. The relationship between real interest rates and inflation is ambiguous, but for certain parameter values there may be a negative relationship, and hence an empirical long-run trade-off between inflation and unemployment (a long-run Phillips curve).

The Demand for Money in Brunei

Based on data for the 1974–95 period this paper estimates demand for narrow money and broad money in Brunei using the error‐correction specification. Short‐run and long‐run elasticities are estimated with respect to real income, interest rate, expected price level and liquidity. Narrow money is quite responsive to changes in real income and interest rate in both the short and long terms. Broad money is income inelastic regardless of the time horizon, however, it is interest inelastic in the short run but interest elastic in the long run. Price elasticity of money demand is negligible in the short run but quite significant in the long run. Changes in the proportion of commercial bank assets placed in foreign money markets do not seem to affect demand for narrow money but their effect on the demand for broad money is both direct and significant.

Properties of the Monetary Conditions Index

In recent years increasing use has been made in monetary policy analysis of the so-called Monetary Conditions Index (MCI). The index is defined as a linear combination of changes in a short-term real interest rate and in the real effective exchange rate, whose coefficients are equal to the estimated effects of the two financial variables on real aggregate demand or, alternatively, on a price index. The MCI is usually regarded as a measure of the degree of tightness of monetary policy in an open economy. In this paper the properties of the index and its possible uses in monetary policy are investigated by means of a macroeconomic model of the Mundell Fleming Dornbusch type; the reaction of the index to different kinds of aggregate shock is considered. Two possible meanings of the index are discussed: as a measure of the stance of monetary policy in an open economy and as an inflation indicator. It is shown that the index can be misleading in both cases. The MCI is ineffective in signalling changes in the stance of monetary policy in the cases of a financial shock and an exchange rate shock and it may also be misleading in the case of a supply shock. As an inflation indicator the index is also subject to some drawbacks in the case of real shocks. The MCI is to be properly interpreted as a summary measure of the inflationary pressures stemming from the short term real interest rate and the real exchange rate. An MCI constructed for Italy turns out to have been affected in recent years by the wide fluctuations of the lira exchange rate, which were mainly due to shocks originating in the financial and foreign exchange markets.

Real returns on government debt: A general equilibrium quantitative exploration

We extend and apply computable general equilibrium methods to the study of economies with both aggregate uncertainty and uninsured household-specific uncertainty. In our economies the government issues two types of assets: a small denomination, non-interest bearing asset, which we call currency, and a large denomination, interest bearing asset, which we call T-bills. We find that a real interest rate behavior similar to that observed in the U.S. can be sustained as equilibrium behavior in our class of economies. We also find that policy induced real interest rate changes that are perceived as being permanent have significant real effects and that these effects take a few years to be fully realized.

Saving Behavior in Low- and Middle-Income Developing Countries: A Comparison

The relationship between real interest rates, saving, and growth is a central issue in development economics. Using macroeconomic data for a cross-section of countries, we estimate a model in which the intertemporal elasticity of substitution varies with the level of wealth. The estimated parameters are used to calculate, in the context of a simple endogenous growth model, the responsiveness of saving to real interest rate changes for countries at differing stages of development. The hypothesis that the saving rate, and its sensitivity to the interest rate, are a rising function of income finds strong empirical support.

Is sustainable tropical timber production financially viable? A comparative analysis of mahogany silviculture among small farmers in the Brazilian Amazon

Conservationist arguments for international trade restrictions on tropical hardwoods, along with counter-arguments by the wood industry, are both based on the claim that key hardwoods, like mahogany, can be either sustainably managed in their natural forest habitat or sustainably produced in silvicultural settings. This paper examines the financial feasibility of three mahogany planting regimes found among small-scale family farmers in the Brazilian Amazon State of Rondonia: degraded fallow enrichment, agroforest consorciation (e.g., mahogany and coffee), and pure-stand plantation. The sensitivity of net future and present values from each of the three systems to changes in real interest rate of capital, opportunity cost of labor, production time, seedling survival rate, and producer roundwood price was tested under 10 scenarios. Overall, mahogany production was found to be financially viable in 21 of the 30 alternative scenarios considered, with pure-stand plantations offering the most profitable alternative. Based on financial criteria alone the most promising approach to blending tropical timber trade with natural forest conservation would be through mahogany plantations, especially if they are located outside the tropical forest zone of the Amazon region.

COMPANY LIQUIDATIONS, INTEREST RATES AND DEBT

This paper examines the relationship between interest rates and company failure. It argues that the response of insolvencies to changes in interest rates depends on the composition of company debt and whether the change in interest rates is expected or unexpected, real or nominal. It shows that when company debt is at variable interest rates, companies are especially vulnerable to unanticipated changes in real interest rates. Evidence is presented which shows that such changes are a major factor in explaining the aggregate company liquidation rate in England and Wales. Copyright 1995 by Blackwell Publishers Ltd and The Victoria University of Manchester

Government Spending and Consumer Attitudes toward Risk, Time Preference, and Intertemporal Substitution: An Econometric Analysis

We construct a model that considers the direct effects, if any, of government spending on the attitudes of a typical consumer toward risk, time preference, and intertemporal substitution. The null hypothesis is that a growing government sector does not affect the consumer's behavior, and the alternative is that it causes him to become less risk averse, more impatient to consume now rather than in the future, and less responsive to changes in real interest rates. If the alternative hypothesis is correct, then government growth may lead to lower economic growth. Using Greek annual aggregate data, 1960-1990, we can reject the null hypothesis.

Saving Behavior in Low- and Middle-Income Developing Countries: A Comparison

The impact of changes in real interest rates on saving and growth is a central issue in development economics. According to one familiar view, a financial liberalization program which increases real interest rates should encourage saving, thereby boosting investment and growth. While such liberalizations have indeed typically succeeded in raising real interest rates, their impact on private saving has been mixed. This paper uses macroeconomic data for a sample of countries with diverse income levels to estimate a model in which the intertemporal elasticity of substitution varies with the level of wealth. The estimated parameters are then used to calculate, in the context of a simple endogenous growth model, the responsiveness of saving to real interest rate changes for countries at differing stages of development.

Saving Behavior in Low and Middle-Income Developing Countries: A Comparison

The impact of changes in real interest rates on saving and growth is a central issue in development economics. According to one familiar view, a financial liberalization program which increases real interest rates should encourage saving, thereby boosting investment and growth. While such liberalizations have indeed typically succeeded in raising real interest rates, their impact on private saving has been mixed. This paper uses macroeconomic data for a sample of countries with diverse income levels to estimate a model in which the intertemporal elasticity of substitution varies with the level of wealth. The estimated parameters are then used to calculate, in the context of a simple endogenous growth model, the responsiveness of saving to real interest rate changes for countries at differing stages of development.

Changes in world real interest rates and inflationary expectations

Changes in World Real Interest Rates and Inflationary Expectations. —One of the major macroeconomic puzzles has been that the real interest rates were persistently low in the seventies and persistently high in the eighties. The authors use a news framework to investigate the extent to which shocks in real output, money supply, world trade, oil prices, stock prices and expected inflation affect the world and national real interest rates. They find dominant effects on real interest rates from movements in expected inflation rates. This suggests the presence of persistent misperceptions about future inflation and the need of further research into the formation of inflationary expectations.

Financial Deregulation and Household Saving

The last decade has seen widespread domestic financial deregulation in the industrial world, particularly in the United States, United Kingdom and the Nordic countries, resulting in an increase in competition both between banks and saving institutions (thrifts or building societies) as they moved into each others services, and within each-sector.' This opened up new financial options, particularly for households, the sector that was probably most affected by government regulation. For example, there was a significant increase in equity withdrawals from personal housing wealth in both the United Kingdom and United States over the ig8os.2 This period also saw a significant change in household consumption behaviour, the most dramatic illustration being the fall in the household saving ratio in those countries where the process of deregulation has gone furthest. This paper reports the results from estimating a model of household saving using regional data for the United Kingdom, with a particular emphasis on the interaction between household saving and financial deregulation. The estimates are used to calculate the relative importance of different factors in the fall in personal saving over the I98os. I conclude that deregulation lowered the equilibrium level of saving over the I98os, probably 2' percentage points per annum, as well as making saving significantly more dependent on changes in wealth, income and real interest rates. There have been a number of earlier empirical studies looking at the interaction between financial deregulation and household behaviour. Manchester and Poterba (i 989), Miles (I 992) and Koskela et al. (I 992) present empirical evidence on the interaction between deregulation, the housing market, and saving in the United States, United Kingdom and Finland, respectively. Others have estimated saving functions which include variables representing the effects of financial deregulation or have considered the impact of financial deregulation on liquidity constraints in consumption.3 The

Public policies and saving in developing countries

This paper analyzes the effectiveness of public policies in raising saving in developing countries, drawing from estimations of consumption functions for 13 developing countries. As a first step, evidence from time-series and panel data on the role of liquidity constraints affecting consumption functions is provided, suggesting that a public saving rise does not result in an equal reduction in private saving. The second step presents direct evidence on the link between private consumption and government saving based on a more general consumption specification implemented for 1980–1987 country panel data. While indirect effects of public policies via changes in domestic inflation and real interest rates on private saving are shown to be negligible, there are significant effects of public current expenditure cuts or tax hikes on private saving. However, higher public saving is offset only in part by a private saving decline — the exact offset coefficient depending on which fiscal variable is affected (taxation or current expenditure) and on the private sector's perceptions of how permanent the fiscal policy changes are. Therefore public policies play an effective role in raising national saving levels in developing countries.

The Effects of Macroeconomic Announcements on Commodity Prices

AbstractThis article analyzes the immediate reaction of a representative sample of commodity prices and two T‐bill yields to the unanticipated components of thirteen macroeconomic announcements. Surprises in the monetary variables cause the majority of the significant commodity price responses; while these plus other cyclical surprises, such as the unemployment rate, cause significant lumber and T‐bill reactions. The results provide strong support for the policy anticipations hypothesis and against the inflationary expectations hypothesis, i.e., that monetary surprises cause changes in real interest rates rather than in nominal rates only as the inflationary expectations hypothesis contends.

MONETARY POLICY ACTIVISM UNDER MANAGED‐FLOATING EXCHANGE RATES: A CROSS‐COUNTRY COMPARISON

This paper assesses the degree and pattern of monetary policy activism in the United States, Canada, West Germany, the United Kingdom, and Japan during the recent period in which managed‐floating exchange rates prevailed. Floating exchange rates enhance the potency of a discretionary monetary policy. Yet central banks in these countries shifted toward less discretionary monetary targeting during the late 1970s in response to rising inflationary pressures and expectations. But whether such targeting actually reduced policy activism is unclear since targets were expressed in wide ranges and often were missed. Following 1981, at least three of these countries–the United States, Canada, and the United Kingdom–reverted to an avowedly more discretionary pattern of response to changes in real demand pressures, interest rates, and exchange rates. Since mid‐1986, Germany, the United Kingdom, and Japan–and, to a lesser extent, Canada–have intervened heavily in the foreign exchange market and so have greatly increased their official dollar holdings. Moreover, through August 1987, the effects of this intervention on these countries' domestic money supplies apparently have been sterilized only partially.

Une théorie des années quatre-vingt

Seen through the lenses of traditional macroeconomic analyses, the 1980s are highly puzzling. It is especially difficult to understand the persistence of high unemployment in Europe and the de-synchronisation of business cycles in the US and in Europe during the first half of the decade. New «facts» have occurred, which currently available models are not able adequately to explain. This paper offers an alternative analysis of business developments during the 1980s, building on a reconstructed theory of the open economy. Changes in real interest rates and real exchange rates play a major role in this reappraisal: they affect supply decisions and mark-up behaviour of firms operating in an imperfectly competitive environment. Intuitively, we contend that trade relations between the European and American economies are actually too tenuous to generate the traditionally assumed synchronisation of business cycles, and instead are dominated by interactions through financial markets. During the first half of the 80"s, both rising real interest rates and the real appreciation of the dollar induced European firms to raise their mark-ups and to attempt to contain production costs, especially labour costs. But what then happens to mark-ups is just as crucial as what happens to wages: an «exogenous» hike in either breeds «stagflation», insofar as it worsens the terms of the inflation unemployment tradeoff. It may thus be that macroeconomic disturbances — in particular the US «policy mix» — are transmitted negatively. The consequences of such adverse effects were aggravated by the resulting worsening in the fiscal and monetary policy environment, European governments then being impelled to go for pro-cyclical policies. Moreover, the persistent rise in real interest rates had major hysteresis effects that explain the protracted character of the European slump. Such effects also slowed down the recovery, at a time when a depreciating dollar and — moderately — declining real interest rates were favouring a renewal of economic activity in Europe. Slow adjustment to a regime of high real interest rates, together with pro-cyclical policies in Europe as a result of such a regime, explain both the strong persistence of the slump and the slowness of the recovery. As early as 1987, this new theory had led us to forecast a recovery in Europe. Today, the same reasoning induces us to predict that it may well last, even in the event of a recession in the US, but provided interest rates do not to rise further.

Money, Credit, and Business Fluctuations*

This paper provides a critique of standard theories of money, in particular those based on money as a medium of exchange. Money is important because of the relationship between money and credit The process of judging credit worthiness, in which banks play a central role, invokes the collection and processing of information. Like many other economic activities involving information, these processes are not well described by means of standard production functions. Changes in economic circumstances can have marked effects on the relevance of previously accumulated information and accordingly on the supply of credit Changes in the availability of credit may have marked effects on the level of economic activity, while changes in real interest rates seem to play a relatively minor role in economic fluctuations.This alternative view has a number of implications for policy, both at the macroeconomic level (for instance, on the role of monetary policy for stabilization purposes and the choice of targets) and at the microeconomic level.

Real Interest Rates and Home Goods: A Two‐Period Model*

Using a simple model of a small open economy which includes traded and non‐traded goods and output in two periods, we demonstrate that changes in real interest rates will be associated with changes in real exchange rates. A high real interest rate will encourage consumers to substitute away from present and toward future consumption. To transfer consumption of non‐traded goods intertemporally, intersectoral resource flows are required In the simplest model, this in turn requires opposite movements in the real exchange rate over two periods.

Real Exchange Rate Dynamics in a Developing Country

Though the nominal exchange rate is typically a policy instrument in developing countries, the real exchange rate is an endogenous variable that responds to both exogenous and policy-induced shocks. This paper examines the dynamic effects on the real exchange rate of a variety of shocks, such as devaluation, changes in the terms of trade, fiscal policies, trade policies, and changes in foreign real interest rates. Since the path of the real exchange rate differs for different types of shocks, nominal exchange rate policies designed to achieve a target real exchange rate must take these differences into account.