Equilibrium Interest Rate Research Articles

Industrial Robots and Finance

We examine theoretically and empirically the effects of industrial robot adoption on corporate financing. Industrial robots are distinct from other types of physical capital in that they tend to be a substitute for labor. As a result, robots provide a hedge against fluctuations in labor costs. Our model shows that industrial robot adoption reduces a firm's risk and equilibrium interest rate, and increases optimal leverage. We test these predictions using firm-level panel data on robot deployment in five Chinese provinces across multiple industries. Consistent with the role of robots in hedging labor cost risk, robot adoption leads to higher leverage and lower cost of debt, at both extensive and intensive margins. The heterogeneity and staggered nature of robot-friendly policies across both provinces and industries enables making causal claims. The model's more refined predictions, concerning the effects of labor contribution, robot-labor substitution, and robot adjustment costs on the strength of the relation between robot adoption and corporate financing, are also borne out in the data.

Demography and Provisions for Retirement - The Pension Composition, a Behavioral Approach

Pensions may be provided for in a modern society by a mix of several methods, namely by voluntary individual savings, mandatory fully-funded occupational pension systems, mandatory social security financed by pay-as-you-go, and old-fashioned hoarding in cash. Here, we call the specific mixture of the four systems the pension composition. We assume that individual workers decide on their own individual savings, that the fully-funded occupational system is decided upon by the age cohort of the median worker (MW), and that the social security is decided upon by the median voter (MV). In this behavioral approach we distinguish between several social groups, where individuals belong to several groups simultaneously and where the interests of the different groups are only partly coinciding. For a given demography and interest rate, the joint result of the decisions of the different age cohorts is a Pareto equilibrium. For ease of exposition we assume that individual and collective pension savings are the only sources of capital supply. When capital supply equals demand from industry there is equilibrium in the capital market with a corresponding equilibrium interest rate. In this paper we assume a demography with one hundred age brackets and we investigate how changes in the birth rates, survival rates, and the retirement age affect the pension composition and the capital market equilibrium. Our conclusion is that the demographic effects are considerable not only for the resulting pension composition but also for macro-economic variables such as the wage rate, the interest rate, and the capital-income ratio. It follows that the pension composition in general and social security in particular is determined by the demography and cannot be modified at will as a long-term political instrument. We find that this is relevant for the present century, where birth and mortality rates in most western countries are steeply declining.

Demography and Provisions for Retirement: The Pension Composition, a Behavioral Approach

Pensions may be provided for in a modern society by a mix of several methods, namely by voluntary individual savings, mandatory fully-funded occupational pension systems, mandatory social security financed by pay-as-you-go, and old-fashioned hoarding in cash. Here, we call the specific mixture of the four systems the pension composition. We assume that individual workers decide on their own individual savings, that the fully-funded occupational system is decided upon by the age cohort of the median worker (MW), and that the social security is decided upon by the median voter (MV). In this behavioral approach we distinguish between several social groups, where individuals belong to several groups simultaneously and where the interests of the different groups are only partly coinciding. For a given demography and interest rate, the joint result of the decisions of the different age cohorts is a Pareto equilibrium.For ease of exposition we assume that individual and collective pension savings are the only sources of capital supply. When capital supply equals demand from industry there is equilibrium in the capital market with a corresponding equilibrium interest rate. In this paper we assume a demography with one hundred age brackets and we investigate how changes in the birth rates, survival rates, and the retirement age affect the pension composition and the capital market equilibrium.Our conclusion is that the demographic effects are considerable not only for the resulting pension composition but also for macro-economic variables such as the wage rate, the interest rate, and the capital-income ratio. It follows that the pension composition in general and social security in particular is determined by the demography and cannot be modified at will as a long-term political instrument. We find that this is relevant for the present century, where birth and mortality rates in most western countries are steeply declining.

Natural Rate Chimera and Bond Pricing Reality

Incorporating arbitrage-free term-structure dynamics into a semi-structural macro-model, we jointly estimate the real equilibrium interest rate (r), trend inflation, and term premia for the United States and the euro area, using a Bayesian approach. The natural real rate and trend inflation are cornerstones determining equilibrium yields across maturities and macroeconomic trends. Taking into account the secular decline in equilibrium rates, term premia exhibit cyclical behavior over the business cycle, rather than the commonly reported trend. Our estimates suggest a fall in r from a pre-crisis level of about 3% to around zero, but estimates are subject to sizeable uncertainty. Including survey expectations can lift r estimates for recent quarters by a margin.

The network nature of over-the-counter interest rates

Interest rates in money markets are fundamental indicators of the smooth transmission of the policy rate and of the stability of the financial system. The decentralized nature of this market can generate equilibrium interest rates that depend on the structure of the relationships among banks. I propose a structural econometric model to test it. The method is applied to a unique dataset of euro unsecured loans and characteristics of banks from 2008 to 2012. I find that the network structure played a greater role during the sovereign debt crisis, when risk preferences and bargaining powers of market participants changed dramatically.

The learning premium

We find equilibrium stock prices and interest rates in a representative-agent model where dividend growth is uncertain, but gradually revealed by dividends themselves, while asset prices reflect current information and the potential impact of future knowledge. In addition to the usual premium for risk, stock returns include a learning premium, which reflects the expected change in prices from new information. In the long run, the learning premium vanishes, as prices and interest rates converge to their counterparts in the standard setting with known dividend growth. If both relative risk aversion and elasticity of intertemporal substitution are above one, the model reproduces the increase in price-dividend ratios observed in the past century, and implies that—in the long run—price-dividend ratios may increase a further forty percent above current levels.

The Global Equilibrium Real Interest Rate: Concepts, Estimates, and Challenges

Real interest rates have been persistently below historical norms over the past decade, leading economists and policymakers to view the equilibrium real interest rate as likely to be low for some time. Various definitions and approaches to estimating the equilibrium real interest rate are examined, including approaches based on the term-structure of interest rates and small macroeconomic models. The individual-country approaches common in the literature are extended to allow for global trend and cyclical factors. The analysis finds that global factors dominate the downward trend in the equilibrium interest rate across 13 advanced economies. A corollary of this finding is that the U.S. equilibrium rate may be substantially lower than estimated in U.S.-only studies. The analysis also highlights how the common global trend confounds empirical assessments of the determinants of movements in the equilibrium rate and the need to better integrate term-structure and macroeconomic approaches.

Joint logistics and financial services by a 3PL firm: Effects of risk preference and demand volatility

This paper considers a third-party logistics (3PL) firm that provides integrated logistics and financial services to a budget-constrained manufacturer with different risk preferences. We adopt a mean–standard deviation objective function to reflect different risk preferences and concentrate on the effects of risk preference and demand volatility. Interestingly, we discover that substitution and complementary effects exist between the interest and freight rates of the 3PL firm. The effects of risk preference and demand volatility on the equilibrium interest rate become more significant when supply chains engage in price competition. Furthermore, we demonstrate that the 3PL firm prefers a risk-averse manufacturer.

Equilibrium real interest rates and the financial cycle: Empirical evidence for Euro area member countries

We estimate the equilibrium real interest rate for nine Euro area member countries and the Euro area as a whole using quarterly data from 1995 to 2015. We expand the standard model of estimating real equilibrium interest rates to incorporate the financial cycle for the private sector. We show that adding the financial cycle indeed alters the equilibrium real interest rate estimates and, in line with previous studies, that there is a fall in the equilibrium real interest rate over time. Our results indicate that in most member countries the real rate is lower than its equilibrium level. Hence, they should not worry about secular stagnation now. This is because secular stagnation is likely to occur when real interest rates are higher than their equilibrium levels. This result can serve as a starting point for further research in this field, e.g. by adding public sector financial cycles or disentangling the roles of households, corporations and the government.

Inflation‐Indexed Bonds and Nominal Bonds: Financial Innovation and Precautionary Motives

AbstractThis paper introduces a two‐period monetary general equilibrium model with proportional transaction costs on nominal and inflation‐indexed bonds. This paper demonstrates that financial innovation on indexed bonds causes equilibrium interest rates of the nominal bond to increase when agents have precautionary saving motives. This result implies that ignoring precautionary motives would underestimate savers' welfare gain and overestimate borrowers' welfare gain from innovation on indexed bonds.

Unveil the economic impact of policy reversals: the China experience

PurposeThe purpose of this paper is to reveal the economic impact of policy reversals related to market liberalization reforms in China.Design/methodology/approachTo perform the analysis, the authors hand-collect 59 financial market liberalization policy reversals from 1999 to 2017. These reversals are related to the liberalization of the stock market, bond market, derivatives market, forex market, lending market, and real estate market etc. The authors employ a stylized equilibrium interest rate model from Li et al. (2013) to deduce the impact of policy reversals on economic growth and the associated volatility after the announcement of each policy reversal.FindingsFirst, the authors discover that about half of reversals are related to some tradeoff between the economic growth and the volatility associated with growth. Second, the authors also find that about a quarter of the reversals are detrimental to both the growth and the stability. These reversals, if known to policymakers, should be entirely avoided or corrected. Third, using a simple diagnostic test, the authors can identify detrimental reversals at the intra-day frequency by computing the change of the term spread and the volatility before and after the reversals.Practical implicationsThe findings are useful for identifying effective policymaking in developing countries where mature democratic and rigorous policymaking processes are often lacking and formulating economic policies is challenging. The findings suggest that policy reversals serve China well by improving the quality of the policy made without posing destructive consequences to the existing economic infrastructure. This empirical evidence is important for a better understanding of the benefits of policy reversals on economic growth.Social implicationsThe empirical procedure provides a timely and objective evaluation of policy shifts, allowing for the general public to discern the rationale behind the policy decisions. Consequently, stakeholders’ trust and confidence in policymakers is enhanced so that the probability of the successful implementation of structural reforms may increase in these developing countries.Originality/valueFirst, the results reveal some successful examples of Chinese policymaking in the path of liberalizing financial market. The authors find that the Chinese liberalization policy flip-flops have resulted in a more balanced growth on some occasions with reduced growth rate and volatility. Second, the proposed methodology provides an objective evaluation of policy shifts, allowing for the public to infer the general direction of the impact generated by policy shifts. Subsequently, stakeholders’ trust and confidence in policymakers can be enhanced and/or restored if the process of finding a successful path of structural reforms is unambiguous. Finally, the interest rate model also provides a timely method to evaluate the impact of policy shifts at an intra-day frequency, whereas most macroeconomic indicators are available at longer frequencies such as monthly or quarterly. The timeliness in understanding the economic consequences of policy reversals can be critical to prevent the destructive consequences of bad ones.

Investment, Consumption and Asset Pricing Model with Ambiguity Aversion

In this paper, we incorporate ambiguity aversion into production-based asset-pricing model of Eberly and Wang (2009b). We derive explicitly the optimal investment, consumption, Tobin’s q, equity premium, equilibrium interest rate and growth rate of capital. We examine the impact of ambiguity aversion on the solutions of model. This paper shows that the relationship between optimal investment, consumption, Tobin’s q and the growth rate of capital and ambiguity aversion is affected by the elasticity of intertemporal substitution. The equilibrium interest rate increases with ambiguity aversion. We separate the impact of risk aversion from the risk aversion on equity premium.

Anti-Corruption Reforms and Microfinancing: Evidence from Households' Fintech Borrowing

Despite a surging literature in investigating different impacts of corruption and/or anti-corruption from firms’ perspective, it is still unclear whether and how corruption and/or anti-corruption affect households’ borrowing behaviour. In this paper, we focus on a Chinese online peer-to-peer lending market and analyse the impact of the recent China’s anti-corruption campaign on households’ borrowing costs. We employ a Difference-in-Differences (DID) estimation strategy and investigate three exogenous shocks regarding the movement: 1) the 2012 Eight Point Policy announcement; 2) multiple rounds of the Central Inspection Team Campaigns during 2013 and 2014; 3) and the anti-corruption rules for military-related personnel in early 2015. Our results show that equilibrium interest rates of borrowers pertaining to Non-SOEs dropped significantly comparing to that of SOEs and/or government agencies in the wake of the first two events. Borrowers affiliating with military-related institutions were also worsened after the military specific anti-corruption campaign. Finally, we examine the two possible economic channels. Suggestive evidences show that both a rise of interest risk premium for SOEs borrowers and a better outlook of Non-SOEs after the anti-corruption reform could account for the observed favour of the borrowing costs towards Non-SOEs borrowers. These findings are consistent with previous studies regarding the effects of anti-corruptions from firms’ aspects such as Lin et al., (2016) and Griffin et al., (2016). This study also complements the P2P literature by demonstrating the importance of online borrowers’ occupations / job affiliations.

Who Bears the Welfare Costs of Monopoly? The Case of the Credit Card Industry

How are the welfare costs from monopoly distributed across U.S. households? We answer this question for the U.S. credit card industry, which is highly concentrated, charges interest rates that are 3.4 to 8.8 percentage points above perfectly competitive pricing, and has repeatedly lost antitrust lawsuits. We depart from existing competitive models by integrating oligopolistic lenders into a heterogeneous agent, defaultable debt framework. Our model accounts for 20 to 50 percent of the spreads observed in the data. Welfare gains from competitive reforms in the 1970s are equivalent to a one-time transfer worth between 0.24 and 1.66 percent of GDP. Along the transition path, 93 percent of individuals are better off. Poor households benefit from increased consumption smoothing, while rich households benefit from higher general equilibrium interest rates on savings. Transitioning from 1970 to 2016 levels of competition yields welfare gains equivalent to a one-time transfer worth between 1.87 and 3.20 percent of GDP. Lastly, homogeneous interest rate caps in 2016 deliver limited welfare gains.

An Estimate of the Long-Term Neutral Rate of Interest

This note proposes a new measure of the high-frequency equilibrium interest rate, one that falls naturally out of a common textbook notion of the economy's equilibrium interest rate--and which is rooted in one particularly simple and well-known model.

DEBT STABILIZATION IN A NON-RICARDIAN ECONOMY

In models with a representative infinitely lived household, tax smoothing implies that the steady state of government debt should follow a random walk. This is unlikely to be the case in overlapping generations (OLG) economies, where the equilibrium interest rate may differ from the policy maker's rate of time preference. It may therefore be optimal to reduce debt today to reduce distortionary taxation in the future. In addition, the level of the capital stock in these economies is likely to be suboptimally low, and reducing government debt will crowd in additional capital. Using a version of the Blanchard-Yaari model of perpetual youth, with both public and private capital, we show that it is optimal in steady state for the government to hold assets. However, we also show how and why this level of government assets can fall short of both the level of debt that achieves the optimal capital stock and the level that eliminates income taxes. Finally, we compute the optimal adjustment path to this steady state.

Causal Strategic Inference in a Game—Theoretic Model of Multiplayer Networked Microfinance Markets

Performing interventions is a major challenge in economic policy-making. We present causal strategic inference as a framework for conducting interventions and apply it to large, networked microfinance economies. The basic solution platform consists of modeling a microfinance market as a networked economy, learning the model using single-sample real-world microfinance data, and designing algorithms for various causal questions. For a special case of our model, we show that an equilibrium point always exists and that the equilibrium interest rates are unique. For the general case, we give a constructive proof of the existence of an equilibrium point. Our empirical study is based on microfinance data from Bangladesh and Bolivia, which we use to first learn our models. We show that causal strategic inference can assist policy-makers by evaluating the outcomes of various types of interventions, such as removing a loss-making bank from the market, imposing an interest-rate cap, and subsidizing banks.

VOLUNTARY VERIFIABLE INFORMATION DISCLOSURE AND LOAN FUNDING PERFORMANCE: EVIDENCE FROM PAIPAIDAI IN CHINA

We investigate what mechanism helps to motivate the willingness of Chinese people to lend money to strangers online in the peer-to-peer (P2P) lending market. We argue that the voluntary verifiable information disclosure created by Chinese P2P practitioners helps to mitigate the asymmetric information problem and facilitates lending transactions between lenders and borrowers. We exploit a unique individual level data set obtained from Paipaidai, a leading Chinese P2P company, and evaluate the extent that the voluntary verifiable information disclosure helps to ease adverse selection problems. We find that information disclosure does increase the probability that a loan listing will be successfully funded by around 10% on average. We also find that the voluntary verifiable information disclosure helps to decrease the equilibrium interest rate by around 0.2% on average.

Estimating Key Economic Variables: The Policy Implications

The current monetary policy debate has focused on current estimates and the future path of the natural rate of unemployment and the equilibrium interest rate. Estimates of the natural rate of unemployment should vary over time with changes in demographics and improvements in human capital. However, these changes should be gradual. This paper shows that the estimates of the natural rate of unemployment by Federal Reserve officials and private-sector economists seem to move pro-cyclically, potentially showing too much weight given to short-term fluctuations in economic variables. As with the natural rate, there are good reasons to expect the equilibrium interest rate to change over time. In fact, the level may actually be more responsive to current economic data, reflecting changes in aggregate savings and investment. Yet, we see that equilibrium interest rate estimates by both Federal Reserve officials and private-sector economists have declined quite dramatically over the past five years. A potential concern raised in this paper is that estimates of these critical economic variables for policy determination appear to be overly sensitive to high frequency economic data.

Ultra Short Tenor Yield Curves for High-Frequency Trading and Blockchain Settlement

Blockchain, based on the distributed ledger technology, provides immediate settlement of transactions of digital assets and direct ownership. Since settlement of transactions is immediate, the blockchain system requires an ultra short tenor interest rate curve that is always up-to-date. Today, many market-quoted rates are still accrued at the end of each trading day, typically with one day as the shortest tenor available. This paper develops an interbank money market model for the equilibrium interest rate of ultra short tenor and updated at an intraday level with automated adjustment for the event of a flash crash. Apart from facilitating trades settlement on blockchain, our research findings are vital for central banks' efforts in stabilizing the currencies during flash crashes. We show that during the flash crash on 15 January 2015 when the Swiss National Bank (SNB) dropped the floor of CHF 1.2 per EUR, the ultra short CHF interest rates should have been highly negative to incentivize market makers to provide liquidity during the sharp CHF appreciation and to neutralize the arbitrage activities that aggravated the crash.