Ex-ante Real Interest Rates Research Articles

What have been the Effects of Monetary and Exchange Rate Shocks on Brazilian Agriculture GDP? The Direct and Indirect Effects Approach

From 1996 to 2016, Brazil faced great fluctuations in both its exchange and interest rates and simultaneously a huge growth of its agriculture has taken place. Examining the literature that deals with the relationships among these three variables (interest rate, exchange rate and agriculture GDP) we verified that monetary and exchange shocks can affect directly and/or indirectly (through relative prices) the agriculture GDP. However, these effects can be coincident or contrary between them. What actually happened in Brazil from 1996 to 2016? This article aimed to access the direct and indirect effects of monetary and exchange rate shocks on Brazil´s agriculture GDP taking into consideration years ranging from 1996 thru 2016. Using quarterly data for the 1996-2016 period, autoregressive vector models (VAR and VEC) were estimated. The exchange rate and monetary shocks were analyzed considering three different interest rate types, namely: the current Brazil´s Federal Funds Rate (Nominal SELIC rate), real interest rate of agricultural loans, and ex-ante real interest rate. We also analyzed the effect of the exchange rate separately on prices paid and on prices received by the agriculture (both make up the relative prices of agriculture) using an ARDL (Distributed Lag Self-Regressive Model) model with monthly data. Our econometric results revealed that both direct and indirect effects of monetary shocks were negative on the agriculture growth while the direct and indirect effects of exchange rate shocks were mutually contradictory themselves on the Brazil´s agriculture GDP. Because of the technical changes that have taken place during the 2000s and the 2010s, which turned some of the most representative crops more dependent on imported inputs, and the hedging behavior that the firms have adopted during the first two decades of the 21st century, which protects them from exchange oscillations, the agricultural sector lost sensitivity to the exchange rate variations in some extent. Regarding policy implications, it could be said that monetary policy can be efficient in the promotion of the agricultural sector, and, in fact, Brazilian government has been doing such through the rural credit subsidized interest rate. Exchange policy, on the other hand, proved to be inefficient in favoring the agriculture, or, in other words, the government can freely exercise exchange policy without regards to harm the agricultural sector.

Dynamics and synchronization of global equilibrium interest rates

ABSTRACT Empirical estimates of equilibrium real interest rates are so far mostly limited to advanced economies, since no statistical procedure suitable for a larger set of countries is available. This is surprising, as equilibrium rates have strong policy implications in emerging markets and developing economies as well. Current estimates of the global equilibrium rate rely on only a few countries but estimates for a more diverse set of countries can improve understanding of its dynamics and drivers. This paper uses a model and estimation strategy that decompose ex-ante real interest rates into permanent and transitory components even with short samples and high volatility. This is done with an unobserved component local level stochastic volatility model, which is used to estimate equilibrium rates for 50 countries with Bayesian methods. Equilibrium rates were lower in emerging markets and developing economies than in advanced economies in the 1980s, similar in the 1990s, and have been higher since 2000. In line with economic integration and rising global capital markets, synchronization has been rising over time and is higher among advanced economies. Equilibrium rates of countries with stronger trade linkages and similar demographic and economic trends are more synchronized.

Inflation Expectations and Consumption: Evidence from 1951

We use rich microdata from the 1951 Survey of Consumer Finances to study inflation expectations and consumption in the United States around the start of the Korean War. At the time, the Treasury required the Federal Reserve to hold nominal interest rates constant, so increases in expected inflation corresponded to reductions in the ex-ante real interest rate (similar to a zero lower bound episode). The survey data includes measures of respondents' actual spending on durables, cars, and homes in 1950, and expected expenditures in these categories in 1951, at both the extensive and intensive margins. The data also includes detailed income and asset data from which we can infer respondents' total consumption in 1950. We find that durables consumption and total consumption in 1950 increase with expected inflation, while expected consumption in 1951 of durables, cars, and homes decreases (though only statistically significantly for cars). Our results are consistent with consumers shifting consumption forward intertemporally in response to lower real interest rates.

Has the Financial Crisis affected the Real Interest Rate Dynamics in Europe?

We investigate the effects of the financial crisis on the stationarity of real interest rates for a group of Euro area countries. We use a new unit root test developed by Pesaran et al. (J Econom 115(1): 53–74, 2013) that allows for multiple unobserved factors in a panel set up. In this multifactor framework, we make use of a number of additional variables such as the stock price volatility and monetary policy expectations that are assumed to share common factors with the real interest rate. Based on recursive (Pesaran et al. 2013) test statistics, our results suggest that while short-term and long-term real interest rates were stationary before the financial crisis, they became non-stationary during the crisis period. Robustness analysis shows that the results are not sensitive to the use of ex-post real interest rates versus ex-ante real interest rates.

Real interest rate differentials between Central and Eastern European countries and the euro area

Research background: The question of changes in real interest rates differentials between the Euro Area and the CEE countries in the last years is raised because of two main reasons. The first rationale is related to the growing importance of external financial factors for the CEE economies and their monetary autonomy. The second reason is associated with the unprecedented shift in monetary conditions in the EMU, brought about by negative interest rates policy and unconventional policies, and the way it impacts the real rates in the CEE economies.
 Purpose of the article: This paper aims at exploring the relationship between real interest rates in the Euro Area and ten countries: Albania, Bulgaria, the Czech Republic, Hungary, North Macedonia, Moldova, Poland, Romania, Turkey, and Ukraine. The analysis covers the years of 1999-2018, including periods before and after the financial and economic crisis.
 Methods: We employ Markov-switching regression to construct the ex-ante real interest rates series in each country, using monthly data on short-term interest rates and CPI inflation rates. A battery of unit root and stationarity test, both standard and panel ones, is applied to examine the real interest rate parity, also allowing for a structural break in the rate differentials.
 Findings & Value added: We provide detailed evidence on the real interest rates differentials for all of the CEE countries vis-?-vis the Euro Area. We find that, while panel stationarity tests point to the stability of real rate differentials, there are significant dissimilarities across the countries, and the results of the univariate tests are often mixed. At least half of the economies, however, reveal similar patterns of stationarity in real rates relationships. At the same time, we find differentials for the Czech Republic, Hungary, and Poland, countries highly integrated into the EMU economy, to be unstable over time.

The effectiveness of unconventional monetary policy announcements in the euro area: An event and econometric study

We use daily data on government bond yields and market-based inflation expectations to measure the announcement effects of unconventional monetary policy announcements in the euro area, focusing on their impact on ex-ante real interest rates. We find evidence of statistically significant effects of several announcements on real interest rates at maturities of two, five and ten years that operate partly through nominal interest rates and partly by raising inflation expectations. Announcements that exceeded market expectations significantly reduced nominal and real interest rates while announcements that disappointed expectations had the opposite effect.

Reflections on and Inquiry into Unfamiliar as well as Familar Factors that may Influence the Market for Municipal Bonds

This study investigates the impact of various factors on the ex-ante real interest rate yield on high grade municipal bonds. The AR/2SLS estimation implies that this ex ante real interest rate is an increasing function of the ex-ante real interest rate yield on thirty-year Treasury bonds while being a decreasing function of net capital flows. The yield in question also is found to have been negatively impacted by the Depository Institutions Deregulation and Monetary Control Act. Furthermore, the estimation finds that this interest rate measure is a decreasing function of the maximum marginal federal personal income tax rate. In addition, it is found that, in the presence of an interaction term, the ex-ante real interest rate yield on high-grade municipals is an increasing function not only of the budget deficit but also the aggregate tax gap. The policy implications of these results include the need to limit the extent of budget deficits and to also limit the extent of income tax evasion in the U.S., lest there will be significant limitations placed on the ability of towns, cities, counties, and states to create new infrastructure in response to changing demographic and economic circumstances and/or maintain existing infrastructure.

A New Way to Quantify the Effect of Uncertainty

This paper develops a new way to quantify the effect of uncertainty and other higher-order moments. First, we estimate a nonlinear model using Bayesian methods with data on uncertainty, in addition to common macro time series. This key step disciplines the model and allows us to generate data-driven policy functions for any higher-order moment. Second, we use the Euler equation to analytically decompose consumption into several terms--expected consumption, the ex-ante real interest rate and the ex-ante variance and skewness of future consumption, technology growth, and inflation--and then use the policy functions to filter the data and generate a time series for the effect of each term. We apply our method to a familiar New Keynesian model with a zero lower bound constraint on the nominal interest rate and two stochastic volatility shocks, but it is adaptable to any dynamic model. Over a 1-quarter horizon, uncertainty has a very small effect on consumption, similar to the volatility shocks in our model. Over horizons that remove the influence of expected consumption, the effect of uncertainty is an order of magnitude larger. Other higher-order moments have much smaller effects.

Linearly Transforming Variables in the VAR Model, How Does it Change the Impulse Response?

AbstractThis paper analyzes the impulse response function of vector autoregression models for variables that are linearly transformed. The impulse response is equal to the linear transformation of the original impulse response if and only if the shock is equal to the linear transformation of the original shock. In particular, we consider shocks in one error term only, generalized shocks, structural shocks identified by short-run recursive restrictions and structural shocks identified by long-run recursive restrictions. A vector autoregression model with expected inflation, the overnight rate and a long term ex-ante real interest rate that replaces the corresponding long term nominal interest rate, illustrates our results.

Bayesian Inference in Regime-Switching ARMA Models With Absorbing States: The Dynamics of the Ex-Ante Real Interest Rate Under Regime Shifts

One goal of this article is to develop an efficient Metropolis–Hastings (MH) algorithm for estimating an ARMA model with a regime-switching mean, by designing a new efficient proposal distribution for the regime-indicator variable. Unlike the existing algorithm, our algorithm can achieve reasonably fast convergence to the posterior distribution even when the latent regime-indicator variable is highly persistent or when there exist absorbing states. Another goal is to appropriately investigate the dynamics of the latent ex-ante real interest rate (EARR) in the presence of structural breaks, by employing the econometric tool developed. We show that excluding the theory-implied moving-average terms may understate the persistence of the observed EPRR dynamics. Our empirical results suggest that, even though we rule out the possibility of a unit root in the EARR, it may be more persistent and volatile than has been documented in some of the literature.

The End of One Long Deflation: An Empirical Investigation

Did Quantitative and Qualitative Monetary Easing (QQE),'' which has been conducted by the Bank of Japan from April 2013, end the long deflation of the Japanese economy? Answering the question, we constructed a linear projection model to estimate Ex-Ante Real interest Rates (EARRs) and Inflation Expectations (IEs) based on Japanese macroeconomic data. In our empirical study, we obtain two major results. The first result shows that we can observe a sharp decline of an EARR and the sudden increase of an IE after March, 2013, which is consistent with the actual core inflation. Second, estimating dummy variables in the model, we find that a structural break occurred in April, 2013. A regime change (regime shift) of Japanese monetary policy occurred in March or April, 2013. They also present that QQE has a strong effect on the Japanese economy and realized the sharp recovery in 2013. We conclude that the regime change of monetary policy end the Japanese long deflation in 2013.

Do oil prices respond to real interest rates?

We show that the robustness of an inverse relationship between the real interest rate and real oil price depends crucially on how the real interest rate is calculated, and the time-frame of the sample. Consistent with earlier studies, we find that the oil price falls with an unexpected rise in either U.S. or international ex-ante real interest rates. When the ex-post real interest rate is used, the oil price only falls with rises to short-term rates (3months or less). Additionally, the response of the oil price to long-term ex-ante real interest rates must include the period through the mid-2000s for the inverse relationship to appear. In contrast, the oil price consistently falls with unexpected rises in short-term real interest rates throughout the entire sample. We draw two conclusions from the results. The first is that the oil price is consistently responsive to short-term U.S. and international real interest rates, underlying the importance of storage. Second, oil prices have become more responsive to long-term real interest rates over time.

Stock Market Fundamental Valuation and the Implied Equity Risk Premium

This paper examines the empirical performance of a multi-stage growth model for the U.S., U.K., Netherlands stock markets during 1987-2010. This model uses analysts‟ forecasted earnings growth and ex-ante long-term real interest rates and outperforms the simple constant growth model but still requires a time-varying equity risk premium to explain major market movements. The implied equity risk premium is relatively stable during this period, with averages between 5 and 6 percent. A set of risk related explanatory variables explains the implied ERP up to 80 percent which suggests that the implied ERP is indeed a true risk premium and a valid missing link in explaining stock market movements.

Discussion of the Fisher Effect Puzzle: A Case of Non-Linear Relationship

1. Assessing the Fisher equation Analysis of the Fisher equation or, equivalently, of the determination of the real interest rate has been the subject of many studies over the years. It provides a significant challenge because the two key variables to be modelled both appear in expectation and so the impact of how expectations are modelled has to be allowed for along with the other aspects of the problem. The Fisher equation is usually understood to connect the ex-ante real interest rate e t r to ex-ante (or expected) inflation e t π and the observed nominal interest rate it (which many authors regard as fixed in advance of the determination of inflation), so e e t t t r i π = − . The difference between

The Fisher effect, survey data and time-varying volatility

In this paper we study the Fisher hypothesis using Livingston survey data on inflation expectations. We propose a simple model for the ex-ante real interest rate where the standard deviation of survey forecasts is used to correct for heteroskedasticity. The findings of this paper contradict earlier studies. We find supportive evidence for the Fisher hypothesis that the nominal interest rate and expected inflation move one-for-one both in the short and the long run. Our results also suggest that the change of US monetary policy does not have significant effect on the dynamics of the ex-ante real interest rate such as previous work assumes.

The Cyclical Properties of the Term Structure of Interest Rates

This paper studies whether three macroeconomic models (Real Business Cycle Model, Sticky Price Model, and Liquidity Effects Model) similar to those studied in King and Watson - (1996) can generate the behavior of nominal and real term structure found in data. Differing from King and Watson - (1996), we use data on UK index-linked bonds to get a better measure of ex-ante real interest rates. It is found that among the three models the sticky price model generates term structure behavior that matches data findings most closely. The sticky price model is able to generate the downward-sloping average real term structure, the upward-sloping average nominal term structure for maturities between 2 and 6 years, the cyclical property of nominal and real yield spread and 1-year nominal and real interest rates.

On the order of integration of monthly US ex-ante and ex-post real interest rates: New evidence from over a century of data

We use a long series of monthly data that spans over 100 years to examine the dynamics of US ex-post and ex-ante real interest rates. The principal tenet of this study is that the data are not consistent with a unit root in real interest rates, although shocks impinging upon these rates are rather persistent. In addition, our results highlight the importance of modeling long memory not only in the conditional mean but in the power transformed conditional variance as well. Overall, these findings suggest that much more attention needs to be paid to the degree of persistence and its consequences for the economic theories which are still inconsistent with the finding of either near-unit-root or long memory mean-reverting behavior.

The Informational Content of Empirical Measures of Real Interest Rate and Output Gaps for the United Kingdom

In many economies, the monetary policy instrument is the level of short-term nominal interest rates, but the monetary policy stance might be better characterised by the ex-ante real interest rate that this nominal rate implies, relative to some 'neutral' or 'natural' real rate of interest. In this paper, the natural rate of interest and the real interest rate gap - the difference between the actual and the natural real rate of interest - are estimated by applying Kalman filtering techniques to a small-scale macroeconomic model of the UK economy. In this model, the real interest rate gap, the output gap and inflation are related via IS-curve and Phillips-curve relationships. The natural rate of interest is defined as the level of (ex-ante) real interest rates that is consistent with an output gap of zero, that is output at its natural level, in the medium term. Based on these estimates, the paper examines whether empirical measures of the real interest rate gap are a useful tool for policymakers - do they contain additional information relative to the estimated output gap, and does the real rate gap have leading indicator properties for the output gap and inflation? Are these gap estimates of practical use in a policy setting? The paper finds that the real rate gap has leading indicator properties for both the output gap and inflation. Importantly, these properties have varied considerably over time: breaking the sample into four subsamples, it appears that the leading indicator properties for both the output and real rate gap were substantially stronger for the subsample that covers most of the 1980s. After the introduction of the inflation target, post 1992, the relationship between the real interest rate gap and the output gap strengthens, but the leading indicator properties of these gaps for inflation diminish, as might be expected under an inflation-targeting regime.

Estimating Real Interest Rates for the United Kingdom

Any monetary policy maker using a short-term nominal interest rate as the primary policy tool will have an interest in understanding developments in ex-ante real interest rates. In this paper, several methods for calculating real interest rates for the United Kingdom are explored. These include: yields on index-linked bonds; yields on nominal bonds minus an appropriate measure of inflation expectations; and a 'consumption-based' measure - derived from manipulating the first-order condition of a standard household intertemporal optimisation problem. It is found that the basic (power utility) version of the consumption-based model suffers from the standard problems outlined in the literature, so the basic framework is augmented to allow for (external) habit formation in consumption, and a general k-period real interest rate is derived. Interestingly, although the different approaches outlined above can sometimes yield very different estimates of real interest rates, all the measures move more closely together during the post-1992 inflation-targeting period than before. Before 1992, uncertainty about the monetary regime, coupled with persistent expectational errors, may have made it more difficult for agents to forecast real interest rates and inflation.

A two-factor model of the German term structure of interest rates

This paper shows that a two-factor constant volatility model provides an adequate description of the dynamics and shape of the German term structure of interest rates from 1972 up to 1998. The model also provides reasonable estimates of the volatility and term premium curves. Following the conjecture that the two factors driving the German term structure of interest rates represent the ex-ante real interest rate and the expected inflation rate, the identification of one factor with expected inflation is discussed. The estimates are obtained using a Kalman filter and a maximum likelihood procedure including in the measurement equation both the yields and their volatilities.