Higher Nominal Interest Rates Research Articles

Economic Growth, Inflation, and Monetary Policy in Pakistan: Preliminary Empirical Estimates

The recent increase in financial market volatility and the increased surge within developing world to become part of the global market have posed several challenges for policy-makers in the emerging markets to decide on a policy regime— monetary or exchange rate—that suits their needs and could also provide stability to the financial system. In view of the macroeconomic characteristics of these emerging economies, the choice of an appropriate policy becomes important to achieve certain targets such as sizeable domestic and foreign investment, reduced reliance on external borrowings, fiscal discipline, etc. These would require both price and exchange rate stability and country’s ability to deal with external shocks to maintain and achieve sustainable economic growth. Pakistan is no different and until recently had a history of macroeconomic imbalances with extremely high foreign (as well as domestic) debt, high budget and current account deficits, extremely low international reserves, high inflation, high nominal interest rates and low economic growth. The average economic growth over 40 years is around 4 percent. The main focus of any policy has been to achieve a sustainable growth pattern. However, due to a number of macroeconomic imbalances such as high budget deficits, extremely high indebtedness, low savings and investment rates, lack of fiscal discipline, undeveloped financial markets, unstable exchange rates along with high population growth and huge defence expenditure made this task almost impossible. Some of these macroeconomic imbalances contributed to episodes of high inflation and unemployment that the country experienced during most of the period since independence.

How do the financial and oil sanctions affect the Iran's economy: a DSGE framework

PurposeThe purpose of the current paper is to analyze the simultaneous effects of oil sanctions and financial sanctions on Iran's macroeconomic variables in a small open economy in the dynamic stochastic general equilibrium (DSGE) framework.Design/methodology/approachA DSGE model with the new Keynesian approach has been designed for the above mentioned purpose giving consideration to households, production, trade, oil, government and central bank sectors. All of the parameters were calibrated by using geometric means of macroeconomic variables in 2004–2017 as the steady-state values of the variables in the static model.FindingsAmplifying the intensity of the oil sanctions reduces oil production due to decreasing investment, technology and export of oil and reduces the central bank's foreign reserves ratio to the money base that leads to an increasing exchange rate. Furthermore, oil sanctions decrease the government revenues due to a decrease in oil export and by the government imposing an expansionary fiscal policy in the form of increasing current expenditure and preserving construction expenditure to prevent deepening the recession, which causes budget deficit and then the issue of more bonds with a higher nominal interest rate. On the other hand, financial sanctions raise transaction costs and marginal costs in the trade sectors that lead to inflation and a decrease in nonoil export and various kinds of imports. Due to inflation and uncertainty, consumption of a household increases and investment expenditure of a household decreases.Originality/valueTo the best of the author's knowledge, few studies in the world have analyzed the economic effect of the sanctions in the framework of DSGE models. There is no study in Iran to date which investigates the effects of the sanctions in the form of a DSGE model. So, this paper is the first study in Iran and one of the few studies in the world using a DSGE model for analyzing the effects of sanctions. Imposing three kinds of oil sanctions in addition to a financial sanction is another innovation of the current paper.

Deposit spreads and the welfare cost of inflation

High nominal interest rates are associated with high deposit spreads, which is consistent with a model where banks have monopoly power and currency and deposits are substitutes. Therefore, higher interest rates raise the implicit price of banking services, increase bank profits and attract entry into the banking sector. Taking these effects into account, a one percentage point increase in inflation has a welfare cost of 0.083% of GDP, 6.7 times higher than traditional estimates.

Analysis of Mankiw’s Theory of Optimal Seigniorage and Inflationary Taxes in the Iranian Economy: Semi-Parametric Approach

While earning money, seigniorage increases the amount of money and when economic growth is less than the growth of money, it causes inflation in the society. Therefore, in terms of monetary authorities, understanding the behavior of the demand function of money and the amount of income that government can earn through seigniorage with minimal inflationary impact, is necessary and important. The aim of this study is to investigate the Mankiw’s theory of optimal seigniorage in which higher tax rates are associated with higher inflation and higher nominal interest rate; this is to say that government has two ways such as seigniorage and increases the taxes to financing its expenditures. In order to test the Mankiw’s (1987) theory of optimal seigniorage, the seasonal data on nominal rate, inflation and tax rates have been used for the period of 1992-2014 and forementioned relationship was extracted through model estimation in the framework of a semi-parametric model. According to the results, the nominal interest rate has a direct relationship with the consumer price index (inflation) and tax rates in long-term.

A Theory of Inside Money and Reserve Requirement

We study the interactions between the two roles of commercial banks as payment intermediary and credit intermediary. Deposits serve as a medium of exchange, and depositors with liquidity shocks may pay with deposits for real consumptions without withdrawing cash from the banking system. Commercial banks are thus less liquidity-constrained and may over-lend to firms, which leads to over-investment in the economy. A proper reserve requirement, though resulting in a higher nominal interest rate, can eliminate over-investment problem and help the economy achieve socially optimal allocation, and the optimal reserve requirement is increasing with the real return of long-term investment. The empirical evidences are consistent with the theoretic results.

A Multidimensional Empirical Analysis on the Nominal and Real International Fisher Effects with a Mediator Variable

The purpose of this paper is to solve the puzzle of UIP(Uncovered Interest Parity). Here we derive the real IFE(International Fisher Effect) and empirically tests the validity of the real and nominal IFE in the case of KRW/USD exchange rates. In addition, we check the mediation effect of the dI(inflation rate differential) variable by adopting the Baron and Kenny’s(1986) model in our empirical tests. Main findings are as follows: 1) The nominal and the real IFE do not hold in the real world. In addition, the mediator variable of dI does not play an expected role in our empirical test model. 2) We find unexpectedly that the Fisher Effect holds empirically between the two countries. It tells us that the financial/capital markets of the US and Korea have been brought closer beyond our recognition. 3) In the case of the KRW/USD rate, the UIP puzzle might not be a puzzle. That is, the higher nominal interest rates meant the higher real interest rates for Korea due to dR(nominal interest rates differential) has been greater than dI(inflation rates differential) in the two countries.

Fiscal policy in the EU in the crisis: A model-based approach with applications to New EU Member States

This paper uses a multi-region DSGE model with collateral constrained households and residential investment to examine the effectiveness of fiscal policy stimulus measures in a credit crisis. The paper explores alternative scenarios which differ by the type of budgetary measure, their length, the degree of monetary accommodation and the level of international coordination. In particular we provide estimates for New EU Member States where we take into account two aspects. First, debt denomination in foreign currency and second, higher nominal interest rates, which makes it less likely that the Central Bank is restricted by the zero bound and will consequently not accommodate a fiscal stimulus. We also compare our results to other recent results obtained in the literature on fiscal policy which generally do not consider credit constrained households.

Real House Prices in the UK

The housing market plays a fundamental role in the economy, and its functioning affects both consumer welfare and economic stability, as the recent crisis has made clear. Research by Barrell et al. (2010) shows that house prices are a key determinant of financial crisis probabilities in OECD economies, and contribute significantly towards systemic banking risk. This must lead the regulator to assess carefully the role of the housing market in this relationship, and if necessary impose regulatory restrictions on the market so as to ensure it functions in a way that reflects the best interests of the economy. In this note we look at the evolution of real house prices in the UK, noting that they have a strong cyclical pattern. We then look at the factors that might affect the evolution of real house prices, and we estimate a dynamic equation describing those prices. After considering a wide set of factors, we demonstrate that there is little role for the supply of housing relative to the number of households. This may be because the ratio of these two variables has been relatively constant over the past thirty years. We show that real borrowing costs, real incomes and the loan-to-income ratio are significant factors determining the long-run path of real house prices, and that front loading problems from high short-term nominal interest rates affect the path of adjustment. Overvaluations can persist for years, and we would judge that real house prices are currently fundamentally overvalued by around 10 per cent. If loan-to-income ratios are reduced then the fundamental overvaluation will increase, and such a policy will put further downward pressure on real house prices.

Fiscal Policy in the EU in the Crisis: A Model-Based Approach

This paper uses a multi region DSGE model with collateral constrained households and residential investment to examine the effectiveness of fiscal policy stimulus measures in a credit crisis. The paper explores alternative scenarios which differ by the type of budgetary measure, its length, the degree of monetary accommodation and the level of international coordination. In particular we provide estimates for New EU Member States where we take into account two aspects. First, debt denomination in foreign currency and second, higher nominal interest rates, which makes it less likely that the Central Bank is restricted by the zero bound and will consequently not accommodate a fiscal stimulus. We also compare our results to other recent results obtained in the literature on fiscal policy which generally do not consider credit constrained households.

A Meta-Analysis of the Equity Premium

The equity premium is a key parameter in asset allocation policies. There is a vigorous debate in the literature regarding the actual measurement of the equity premium, its size and the determinants of its variation. This study aims to take stock of this literature by means of a meta-analysis. We identify how the size of the equity premium depends on the way it is measured, along with its evolution over time and its variation across regions in the world. We find that the equity premium is significantly lower if measured by ex ante methods rather than ex post, in more recent periods, and for more developed countries. In addition, looking at the underlying fundamentals, we find that larger volatility in GDP growth tends to raise the equity premium while a higher nominal interest rate has a negative impact on the equity premium.

A Meta-Analysis of the Equity Premium

The literature on the equity premium vigorously debates how to measure the premium, what is its size and what determines its variation. This study provides a quantitative survey of the literature through a meta-analysis. We identify how the size of the equity premium depends on the way it is measured, along with its evolution over time and its variation across regions in the world. We find that the equity premium is significantly lower in measurements by ex ante rather than ex post methods, in more recent periods, and in more developed countries. Looking at the underlying fundamentals, we find that larger volatility in GDP growth tends to raise the equity premium, while a higher nominal interest rate has a negative impact on the equity premium.

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Monetary Policy, Expected Inflation, and Inflation Risk Premia

Within a New Keynesian business cycle model, we study variables that are normally unobservable but are very important for the conduct of monetary policy, namely expected inflation and inflation risk premia. We solve the model using a third-order approximation that allows us to study time-varying risk premia. Our model is consistent with rejection of the expectations hypothesis and the businesscycle behaviour of nominal interest rates in US data. We find that inflation risk premia are very small and display little volatility. Hence, monetary policy authorities can use the difference between nominal and real interest rates from index-linked bonds as a proxy for inflation expectations. Moreover, for short maturities current inflation is a good predictor of inflation risk premia. We also find that short-term real interest rates and expected inflation are significantly negatively correlated and that short-term real interest rates display greater volatility than expected inflation. These results are consistent with empirical studies that use survey data and index-linked bonds to obtain measures of expected inflation and real interest rates. Finally, we show that our economy is consistent with the Mundell-Tobin effect: increases in inflation are associated with higher nominal interest rates, but lower real interest rates.

Effects of inflation on wealth distribution: Do stock market participation fees and capital income taxation matter?

The effects of a permanent change in inflation on the distribution of wealth are analyzed in a general equilibrium OLG model that is calibrated with regard to the characteristics of the US economy. Poor agents accumulate savings predominantly in the form of money, while rich agents participate in the stock market and accumulate equity. Higher inflation results in higher nominal interest rates and a higher real tax burden on interest income. Surprisingly, an increase in inflation results in a lower stock market participation rate; in addition, savings decrease and the distribution of wealth becomes even more unequal.

Fighting Against Currency Depreciation, Macroeconomic Instability, and Sudden Stops

In this paper we show that, in the aftermath of a currency crisis, a government that adjusts the nominal interest rate in response to domestic currency depreciation can induce aggregate instability in the economy by generating self-fulfilling endogenous cycles. We find that, if a government raises the interest rate proportionally more than an increase in currency depreciation, then it induces selffulfilling cycles that, driven by people’s expectations about depreciation, replicate several of the salient stylized facts of the “Sudden Stop” phenomenon. These facts include a decline in domestic production and aggregate demand, a collapse in asset prices, a sharp correction in the price of traded goods relative to non-traded goods, an improvement in the current account deficit, a moderately higher CPI-inflation, more rapid currency depreciation, and higher nominal interest rates. In this sense, an interest rate policy that responds to depreciation may have contributed to generating the dynamic cycles experienced by some economies in the aftermath of a currency crisis.

Fighting Against Currency Depreciation, Macroeconomic Instability and Sudden Stops

In this paper we show that, in the aftermath of a currency crisis, a government that adjusts the nominal interest rate in response to domestic currency depreciation can induce aggregate instability in the economy by generating self-fulfilling endogenous cycles. We find that, if a government raises the interest rate proportionally more than an increase in currency depreciation, then it induces selffulfilling cycles that, driven by people's expectations about depreciation, replicate several of the salient stylized facts of the "Sudden Stop" phenomenon. These facts include a decline in domestic production and aggregate demand, a collapse in asset prices, a sharp correction in the price of traded goods relative to non-traded goods, an improvement in the current account deficit, a moderately higher CPI-inflation, more rapid currency depreciation, and higher nominal interest rates. In this sense, an interest rate policy that responds to depreciation may have contributed to generating the dynamic cycles experienced by some economies in the aftermath of a currency crisis.

Uncovered Interest Parity Revisited

A standard empirical finding in international finance is that countries with high nominal interest rates experience appreciations of their currencies, in contrast to predictions based on uncovered interest parity (UIP). However, tests of UIP have almost exclusively relied on data on short‐term interest rates. In this paper, UIP is tested on long‐term government bond yields. Since the presence of coupon payments induces a measurement error between the observed data and true returns, several different proxies for the latter are constructed. Furthermore, instrumental variable techniques are used. In contrast to thetypical finding, the results are rather favorable to UIP.

Frisch Demand Functions and Intertemporal Behaviour in Consumption: The Turkish Case

This paper examines the intertemporal behaviour in consumption for Turkey which has been experiencing high and chronic inflation since the late 1970s. The Frisch demand system is used to estimate three separate but inextricably intertemporal elasticities: intertemporal price elasticities of demand, commodity-specific intertemporal elasticities, and the intertemporal substitution elasticity of consumption. Our main result is that the Turkish households are reluctant to move their expenditures on non-durable goods from the current period to the next period, regardless of how high nominal interest rates are. This interesting result shows that the consumption behaviour in Turkey has been mainly shaped by uncertainty created by inflationary process and the tendency towards hedging against inflation.

Inflationary Effects of High Nominal Interest Rates

(1998). Inflationary Effects of High Nominal Interest Rates. Journal of Post Keynesian Economics: Vol. 20, No. 4, pp. 583-596.

Money, Banking, and Capital Formation

We consider a monetary growth model in which banks arise to provide liquidity. In addition, there is a government that issues not only money, but interest-bearing bonds; these bonds compete with capital in private portfolios. When the government fixes a constant growth rate for the money stock, we show that there can exist multiple nontrivial monetary steady states. One of these steady states is a saddle, while the other can be a sink. Moreover, paths approaching a steady state can display damped endogenous fluctuations, and development trap phenomena are common. Across different steady states, low capital stocks are associated with high nominal interest rates; the latter signal the comparative inefficiency of the financial system. Also, increases in the steady state inflation rate can easily reduce the steady state capital stock.Journal of Economic LiteratureClassification Numbers: E13, E44, E50, G20, O16.