High Interest Rate Policy Research Articles

Holding out for a haircut: financial crisis, moral hazard, and interest rate policy

The International Monetary Fund (IMF)-prescribed introduction of higher interest rates in crisis-hit economies has been criticized as being unnecessarily contractionary. This criticism ignores the effects of interest rate policy on the incentives to restructure corporate debt once it has become strategically optimal for domestic firms to declare a state of over-indebtedness. A wide-spread state of debt moratoria constitutes a bad equilibrium, whereas the widespread adoption of a quick debt workout strategy is a potentially good equilibrium. The latter can be encouraged through various policies, most controversially a short-term policy of high interest rates. Other potential policies include (i) widespread debt forgiveness; (ii) enhanced implementation of the bankruptcy court; and (iii) the enforcement of free market competition. Copyright @ 2000 by John Wiley & Sons, Ltd. All rights reserved.

EXCHANGE RATE STABILIZATION AND IMF HIGH INTEREST RATE POLICY: A CRITICAL RECONSIDERATION USING A DYNAMIC MODEL

This paper examines whether the IMF high interest rate policy was suitable for crisis-ridden East Asian economies. Using an overshoot model similar to that of Dornbusch's (1976), it shows that this sort of policy might cause an unnecessary deflationary adjusting process and have no effect on containing the real depreciation of exchange rates in the long run. The study also demonstrates that Thai economic data coincides quite well with the model presented here. Finally, it points out that the high interest policy itself might provoke high risk-premium, the existence of which, in turn, justifies the policy. This means that the policy has a self-fulfilling property. In conclusion, a one-size-fits-all adaptation of high interest rate policy in a currency crisis is very dangerous in general, and was inappropriate for East Asia. The desirable policy would have been to let currencies depreciate and keep interest rates stable.

Consequences of a High Interest Rate Policy in the Process of Disinflation. The Case of Poland

The aim of the article is to analyse the consequences of a high interest rate policy pursued in Poland since 1990 in the process of disinflation. The interest rate was the main instrument of monetary policy in a situation when the economy lacked a money market on which the money supply could be influenced directly by open market operations. The application of a high interest rate had many unfavourable consequences both in the real sphere and in the financial sphere. The most important of these consequences in the real sphere was that it forced self-financing on the part of enterprises, the ineffective allocation of resources, delays in carrying out investments, the cyclicity of demand; the effects in the financial sphere mainly concern the banking sector, where the assets of the banking system become distorted, while for enterprises the most important consequences result from the high cost of credit, which increases costs and reduced the competitiveness of enterprises dependent on credit. The authors analyse these consequences and formulate hypotheses and a research programme for testing them.

The UK construction industry under cyclical high inflation, high interest rates and recession

Since 1970, the UK construction industry has suffered three major recessions provoked by a fundamental factor — high inflation. This paper first examines the root causes of cyclical high inflation — labour cost push and excess borrowing. Second, it identifies the necessary conditions for high inflation to lead to a recession through use of a high interest rate policy by the government. Finally, the paper analyses and lists the effects of a high interest rate policy and recession upon the UK construction industry. The purposes of this paper is for project managers to raise awareness of the effects of high inflation and recession, and to attempt to provide guidance for risk analysis in conditions of high inflation, high interest rate policy and recession at a macroeconomic level.

Financial Development in Bangladesh—A Test of the McKinnon-Shaw Model

ABSTRACT This paper empirically tests for Bangladesh the McKinnon-Shaw model of financial development. According to McKinnon, a basic complementarity exists between money and physical capital. That is, money balances and tangible investments are complements rather than substitutes. The McKinnon-Shaw model predicts that a high real interest rate policy will stimulate savings and investment and promote economic growth. This view stands in sharp contrast with the neostructuralist view which contends that lowering the interest rate will stimulate investment and economic growth. Results of the empirical tests, using annual data from 1973 to 1991, provide some support, albeit weak, for the McKinnon-Shaw hypothesis for Bangladesh.

International Constraints and Domestic Choices: Economic Convergence and Exchange Rate Policy in France and Italy

As tensions in the European Monetary System demonstrate, international capital flows can have a decisive influence on countries' economic policies. The external constraint of high international capital mobility led the countries of Western Europe in the 1980s to attempt to stabilize their exchange rates and converge toward low levels of inflation. Yet this process was not uniform: French governments pursued a rigorous anti-inflationary policy of high interest rates and a strengthening currency, while Italian governments had difficulty controlling inflation and maintaining the lira in the European Monetary System. This difference is best explained by comparing political institutions and policymaking processes in the two countries. Particular attention is given to political leaders' access to economic policy tools and their capacity to design and implement long-term goals.

THE POLITICS OF MAASTRICHT

The Economic and Monetary Union (EMU) treaty signed at Maastricht does not guarantee the recreation of German‐style economic policies and outcomes at the European Community (EC) level. Membership was not limited to countries that mimic the German commitment to price stability. National representatives may outvote inflation‐averse EC central bankers in monetary policy decisions. The Council of Ministers has the power to set exchange rate policy vis‐à‐vis third currencies. The treaty does not provide binding constraints against fiscal profligacy in member states. The German government agreed to this suboptimal outcome because in the wake of the demise of the Soviet Union and German unification it had broader political interests in maintaining the pace of European integration at Maastricht. The Bundesbank's policy of high interest rates in 1992, however, has effectively guaranteed a two‐speed monetary union, in which the first group of members will be limited to a narrow deutschemark zone. Given the waning enthusiasm for integration across the EC, the German government has no incentive to alter this outcome.

Some Reflections on the Relation Between Finance and Distribution in the 1980s

Growth and technological change have created difficulties in linking changes in individual and functional distribution. The problem is complicated by changes in financial structure in the 1980s; making it more difficult to trace the effect on distribution of such events is the increase in government indebtedness, high interest rate policy, or the collapse of savings and loan banks. This paper tries to outline these difficulties and is a first step in assessing how these factors affect individual distribution.

Are High Interest Rates Effective for Stopping High Inflation? Some Skeptical Notes

High interest rates are considered an effective toolfor stopping high inflation. The case for a policy of high interest rates is developed in terms of a conventional IS-LM model. However, among other things, the model ignores some central aspects of modern credit markets. In particular high interest rates may give rise to nonperforming bank loans, thus seriously jeopardizing the effectiveness of the policy. Examples are developed in which it would be optimal to aim for equilibriums of low, rather than high, interest rates. One of these examples hinges on the existence of nonindexed domestic debt. This article looks at the effectiveness and desirability of relatively high interest rates in stabilization programs. High interest rates refer to nominal interest rates that would result in unsustainable, high real interest rates-that is, real rates of interest that would cause a state of generalized bankruptcy if maintained for a few months or a year-if the program's inflation target were to be achieved. The article evolves through a series of examples, beginning with the IS-LM model described in section I. Despite its simplicity (and early vintage), the model is still important in discussions of policy. The conventional IS-LM approach, which gives strong support to a policy of high interest rates, implies that tight money is effective in reducing economic activity and, through the Phillips curve, is also effective in lowering inflation. The larger the interest rate, the sooner price stability will be achieved. Section II questions the relevance of the IS-LM result on the basis of two observations. First, we live in a world in which countries are closely linked from a financial point of view. Therefore high interest rates are likely to signal expectations of high devaluation or inflation. Second, high inflation rates make expected or ex ante real interest rates look much smaller than if the stabilization plan's inflation targets were to be fulfilled. Consequently, banks may continue lending despite high nominal rates. With the passage of timne, however, firms will find themselves in serious financial straits, which eventually may result in a state

The Dollar, the Oil Price and Policy Divergence

There is currently a clear divergence of policy between the United States, Japan and Germany. With the US in recession and concern growing over the severity of the slump, interest rates have been cut in a move to revive the economy. In contrast Japan and Germany are both experiencing strong growth and monetary policy remains tight to combat inflation. This divergence was seen most clearly when the Federal Reserve Board lowered its discount rate to 6 per cent on 1 February, the day after the Bundesbank had raised its Lombard rate to 9 per cent. With G7 increasingly concerned about domestic factors, less emphasis is placed upon stable exchange rates and as a result the dollar is at an all-time low. The last two G7 communiqués have stressed ‘stability oriented monetary policies’, an ambiguous phrase which fails to define ‘stability’ either in terms of exchange rates, inflation or growth. Thus both the German and Japanese policy of high interest rates to reduce inflation and low US interest rates aimed at stimulating the economy can be termed as ‘stability oriented’. This analysis focuses on these divergent policy responses in two alternative scenarios to the world forecast we presented last month. The first scenario considers what might happen if the Federal Reserve Board were to stimulate the US economy by further cuts in interest rates, whilst Japanese and German rates were unchanged in the face of inflationary pressures. This case may be relevant if the recent US loosening of monetary policy is not sufficient to encourage growth because of a ‘credit crunch’, so that a more expansionary policy is required by the Fed. As a consequence, policy diverges further and the dollar weakens. The second scenario focuses upon a reduction in inflationary pressures in Japan and Germany brought about by an oil price fall. In this case we assume that US policy is already loose enough to avoid a prolonged recession, but that German and Japanese monetary policy is relaxed as inflationary forces recede. In this case policies converge. Each scenario thus concentrates on one of !he two features which are causing the policy divergence amongst G3 countries: recession in the US, inflation in Germany and Japan.

FINANCIAL FACTORS IN ECONOMIC DEVELOPMENT: A STUDY OF THE FINANCIAL LIBERALIZATION POLICY IN THE PHILIPPINES

The Developing EconomiesVolume 28, Issue 3 p. 240-270 Free Access FINANCIAL FACTORS IN ECONOMIC DEVELOPMENT: A STUDY OF THE FINANCIAL LIBERALIZATION POLICY IN THE PHILIPPINES Hidenobu OKUDA, Hidenobu OKUDASearch for more papers by this author Hidenobu OKUDA, Hidenobu OKUDASearch for more papers by this author First published: September 1990 https://doi.org/10.1111/j.1746-1049.1990.tb00184.xCitations: 3 This paper is a revised and expanded version of my paper, “Keizai hatten ni okeru kin'yū sekutā no yakuwari—Firipin no kin'yū sekuts̄ kaikaku no hyōka—” [The role of the financial sector in economic growth—Assessment of Philippine financial sector], which was published in Kaigal tōshi kenkyūjo hō (Export-Import Bank of Japan), Vol. 16, No. 5 (May 1990). I wish to thank Mario B. Lamberte, Toshihiko Kinoshita, Shōgo Ishii, Anne Emig, and a referee of the journal for helpful comments and suggestions on my previous draft. Any remaining errors are the sole responsibility of my own. AboutPDF ToolsRequest permissionExport citationAdd to favoritesTrack citation ShareShare Give accessShare full text accessShare full-text accessPlease review our Terms and Conditions of Use and check box below to share full-text version of article.I have read and accept the Wiley Online Library Terms and Conditions of UseShareable LinkUse the link below to share a full-text version of this article with your friends and colleagues. Learn more.Copy URL REFERENCES 1 Dornbush, R., and Reynoso, A. Financial Factors in Economic Development,” in National and International Aspects of Financial Policies in LDCs, ed. D. Khatkhate ( Oxford : Pergamon Press, 1980). 2 Hashida, A. Firipin no sangyō kaihatsu kin'yū” [Industrial development finance in the Philippines], in Hatten tojōkoku no sangyō kaihatsu kin'yū [Industrial development finance in the developing countries], ed. K. Itō, Kenkyū sōsho No. 314 ( Tokyo : Institute of Developing Economies, 1983). 3 Kohsaka, A. Keizai hatten to kōkinri seisaku” [Economic development and high interest rate policy], in Keizai hatten to zaisei kin'yū seisaku [Economic development and fiscal and monetary policy], ed. K. Itō, A. Kohsaka, and E. Tajika, Kenkyū sōsho No. 338 ( Tokyo : Institute of Developing Economies, 1984). 4 Matsuoka, K. Tōnan Ajia no kin'yū seisaku to shōgyo kin'yū kikan [Financial policy and commercial finance institutions in Southeast Asia], Kenkyū sōsho No. 327 ( Tokyo : Institute of Developing Economies, 1984). 5 McKinnon, R. I. Money and Capital in Economic Development ( New York : Oxford University Press, 1973). 6 Miralao, L. D., Jr. Kokka kaihatsu keikaku” [National development planning], in Firipin no keizai seisaku to kigyō [Economic policy and corporations in the Philippines], ed. M. F. Montes and K. Koike, ASEAN-tou genchi kenkyū sir?zu No. 2 ( Tokyo : Institute of Developing Economies, 1988). 7 Morgan Guaranty Trust Company. “ LDC Capital Flight,” World Financial Markets, March 1986. 8 Morisawa, K. Firipin ni okeru taigai ruiseki saimu to kaihatsu kin'yū” [ The rapid increase of external debt and development financing in the Philippines—Referring to the behavior of the Development Bank of the Philippines], Kikan keizai kenkyū (Osaka City University), Vol. 9, No. 2 (Autumn 1986). 9 Okuda, H. Models of Taxation on the Financial System in Less Developed Countries,” Ph.D. diss. ( Minneapolis , Minn. : University of Minnesota, 1989). 10 Polvorosa, C. G. Trends and Direction of Bank Lending during 1979–86,” CB Review, Vol. 39, No. 5 (May 1987). 11 Rosario, L. G. Monetary Policy in the Philippines, 1949–86,” CB Review, Vol. 41, No. 1 (January 1989). 12 Sakai, H. An Overview: Postwar Economic Development in the Philippines: Trust, Zeal and Achievement,” in Philippine Macroeconomic Perspective: Development and Policies, ed. H. Sakai and M. F. Montes, ASEDP No. 4 ( Tokyo : Institute of Developing Economies, 1989). 13 Shaw, E. S. Financial Deepening in Economic Development ( New York : Oxford University Press, 1973). 14 Teranishi, J. Kokusai kin'yū to tojōkoku no kin'yū mekanizumu” [International finance and financial mechanisms in developing countries], in Keizai kaihatsu shien to shite no shikin kanryū [Fund recycling as a measure of economic development support], ed. T. Yanagihara, Kenkyū sōsho No. 387 ( Tokyo : Institute of Developing Economies, 1989). 15 Van Wijnbergen, S. Interest Rate Management in LDCs,” Journal of Monetary Economics, Vol. 12, No. 3 (September 1983). 16 World Bank. The Philippines: Aspects of the Financial Sector ( Washington , D.C. : World Bank, 1980). Citing Literature Volume28, Issue3September 1990Pages 240-270 ReferencesRelatedInformation

FINANCIAL LIBERALIZATION IN ASIAN NICs: A COMPARATIVE STUDY OF KOREA AND TAIWAN IN THE 1980s

The Developing EconomiesVolume 25, Issue 4 p. 325-345 Free Access FINANCIAL LIBERALIZATION IN ASIAN NICs: A COMPARATIVE STUDY OF KOREA AND TAIWAN IN THE 1980s Akira KOHSAKA, Akira KOHSAKASearch for more papers by this author Akira KOHSAKA, Akira KOHSAKASearch for more papers by this author First published: December 1987 https://doi.org/10.1111/j.1746-1049.1987.tb00114.xCitations: 3AboutPDF ToolsRequest permissionExport citationAdd to favoritesTrack citation ShareShare Give accessShare full text accessShare full-text accessPlease review our Terms and Conditions of Use and check box below to share full-text version of article.I have read and accept the Wiley Online Library Terms and Conditions of UseShareable LinkUse the link below to share a full-text version of this article with your friends and colleagues. Learn more.Copy URL Share a linkShare onFacebookTwitterLinkedInRedditWechat REFERENCES 1 Arndt, H. W. Financial Development in Asia,” mimeographed, May 1985. 2 Chiu, P. C. H. Performance of Financial Institutions in Taiwan,” in Experiences and Lessons of Economic Development, ed. K. T. Li. and T. S. Yu ( Taipei : Academia Sinica, 1982). 3 Cole, D. C., and Patrick, H. Financial Development in the Pacific Basin Market Economies,” Paper prepared for the 14th Pacific Trade and Development Conference on Pacific Growth and Financial Interdependence, Singapore , June 18–21, 1984. 4 V. Corbo; A. O. Krueger; and F. Ossa, eds. Export-oriented Development Strategies: The Success of Five Newly Industrializing Countries ( Boulder : Westview Press, 1985). 5 Government of the Republic of Korea. The Fifth Five-Year Economic and Social Development Plan, 1982–1986 ( Seoul , 1982). 6 Kim Pyung Joo, ed. Geumyung chedo gaepyeongwa dangi geumyuong hoesaeui baljeon banghyang [Development of short-term finance companies under financial reform] ( Seoul : Korea Federation of Investment and Finance Companies, 1985). 7 Kohsaka, A. The High Interest Rate Policy under Financial Repression,” Developing Economies, Vol. 22, No. 4 (December 1984). 8 Li Yongsan and Chen Shangcheng. Taiwan jinrong fazhan zhi huigu yu qianzhan” [Retrospect and prospect of financial development in Taiwan], in Taiwan jinrong fazhan huiyi [Proceedings of the Conference on Financial Development in Taiwan], ed. Institute of Economics, Academia Sinica, Vol. 1 ( Taipei , 1984). 9 McKinnon, R. I. Financial Liberalization in Retrospect: Interest Rate Policy in LDCs,” mimeographed, 1986 March. 10 Park Yung Chul. Economic Stabilization and Liberalization in Korea, 1980–84,” A paper for presentation at the seminar commemorating the 35th anniversary of the Bank of Korea, 1985 June. 11 Park Yung Chul. Korea's Experience with External Debt Management,” in International Debt and the Developing Countries, ed. G. W. Smith. and J. T. Cuddington ( Washington , D.C. : International Bank for Reconstruction and Development, 1985). 12 Xu Jiachen, et al. Taiwan jinrong tizhi zhi yanjiu [A study of the financial system of Taiwan] ( Taipei : Chung-Hua Institution for Economic Research, 1985). 13 Zhou Qingsheng. Lilü zhengce jiantao yu lilü ziyouhua kexing tujing” [An examination of interest rate policies and feasibility of interest rate liberalization], in Taiwan jinrong fazhan huiyi [Proceedings of the Conference on Financial Development in Taiwan], ed. Institute of Economics, Academia Sinica, Vol. 2 ( Taipei , 1984). Citing Literature Volume25, Issue4December 1987Pages 325-345 ReferencesRelatedInformation

Aspects of the Debate on Interest Rate Policies in Developing Countries

ABSTRACT A decade of thinking about the role of money and monetary policy in developing countries has seen financial liberalization emerge as the new conventional wisdom in the development literature. It has made the eradication of financial “repression”, through the pursuit of positive real interest rate policies, a key macroeconomic objective in a wide range of developing countries. After taking a brief look at the main theoretical arguments of financial liberalization, this paper questions the centrality of the high interest rate paradigm by addressing what appear as some of the most contentious issues in the debate over high interest rate policies, namely their impact on savings, investment and resource allocation, the problem of choosing the appropriate interest rate schedule, the contractionary effects of tight credit policies, as well as the impact of financial liberalization on credit market dualism.

Politique monétaire en économie d'endettement vue à travaes le modèle OFCE-annuel

A model of an overdraft economy is estimated on french data. The main features of it can be summarized as follows : the most part of household's savings is held in money. Thus, the size of the bond market is small. The firms which are constrained on the bond market, have to finance their investments mostly by bank loans. Monetary authorities do not control the money supply because the central bank satisfies all commercial banks' demand for refinancing. The government only controls the cost of credit through the discount rate (day to day loan rate), the reserve-deposit ratio, etc... The interest rate is determined by banks on the credit market. In such an economy the interest rate is the only transmission variable of the monetary policy. Then, it is shown that, with a fixed exchange rate, a high interest rate policy is depressive and inflationary, because an increase of interest rate makes income over from firms to households. These interest costs reduce profits and investment more than they rise the consumption of interest income of households. In addition, the rise of financial costs is inflationary.

Effects of interest rate policy on external balances

The interest rate plays an important but also controversial role in the analysis of economic policy concerning external balances. It is considered an important policy tool in maintaining external balance where exchange rates are fized. 1 R.A. Mundell (1962) in his classic paper on The appropriate use of monetary and fiscal policy for internal and external stability, J.H. Fleming (1962), H.G. Johnson (1967) and others all assumed that high interest rate policies would improve the balance of payments through an improvement in the capital account. The net capital outflow was assumed to be an inverse function of the domestic interest rate. As T.D. Willett and F. Forte (1969) pointed out, these models had three major deficiencies: the use of a flow theory of international capital movements and the failure to take into account the interest cost of capital inflows. A third deficiency of these models is that they overlooked the impact of growth of wealth (portfolios) both in domestic and foreign economies on capital flows. 2 An important consideration in determining the effect of an interest rate policy on external balances, is to account for the time value of money. This is because capital streams occur over a period of time. This point has been overlooked in all previous papers. The only exception is the paper by Lindert (1971) who discounts all payments effects over time. However he addresses himself to the analysis of the impact of foreign investment restriction on the balance of payments and does not consider growth of