Increase In Real Interest Rates Research Articles

Optimal trend inflation in an open economy

We study the optimal inflation target in an open economy with a zero lower bound (ZLB) on nominal interest rates calibrated to the Euro area. When uncovered interest rate parity (UIP) holds, the optimal inflation target is smaller than in a closed economy. The key to this result is that real interest rates at the ZLB increase less as trade openness increases. This less pronounced increase in real interest rates in an open economy mitigates the contraction in aggregate demand, thus reducing the cost of ZLB. Additionally, the optimal inflation target in a monetary union is lower than in a flexible exchange rate regime: forming a monetary union results in a decrease in the optimal inflation rate by 0.24%, thereby increasing per-period welfare by 0.07%. When departures from UIP are significant, the optimal inflation target may be higher than in a closed economy, and the desirability of a monetary union increases further.

Determinants of Domestic Bank Credit to Private sectors in Bangladesh: An Empirical Investigation

This article examines the key determinants of domestic bank credit the private sectors receive in Bangladesh by using annual time series data over the period from 1974 to 2018. The ARDL (autoregressive distributed lag) model has been applied to identify the variables that contribute to the changes in domestic credit to private sectors from banks over time in Bangladesh. Empirical results reveal that broad money (M2), gross domestic product (GDP), real interest rate (RI), trade openness (TO), gross capital formation (GCF), and exchange rate (ER) have a significant impact on the amount of credit flowing to the private sectors from banks in Bangladesh, particularly in the long run. The findings also confirm that the long run relationship among the relevant variables is robust and stable. Any disequilibrium found in the short run seems to be eliminated with a speed of 40.96% per year. The findings of the research suggest that a stable growth of money supply, an increase in real interest rate, sustainable growth in GDP, and high degree trade openness are crucial for the growth of bank credit to private sectors. Gross capital formation and local currency depreciation, on the other hand, negatively influence bank loans to the private sector in Bangladesh. The significance of the study lies in the fact that it paves the way for a better understanding of the functionality of domestic bank credit flow in Bangladesh. The policy implications of the findings suggest that authorities pay special attention to stable money supply growth, expansionary monetary policy, and trade liberalization to strengthen the financial market in Bangladesh.

The time-frequency dependence of unemployment on real input prices: a wavelet coherency and partial coherency approach

ABSTRACTWhile the dependence of unemployment on real oil price and real interest rate is an important issue that has been addressed only in the time dimension, little is known about the movements of real input prices and their impact on unemployment in the time-frequency space. With a continuous wavelet coherency and partial coherency approach and monthly data of Japan and US from January 1960 to May 2017, this paper contributes to the literature by examining the characteristics of the dependence of unemployment on real input prices across frequencies and over time. The empirical results indicate that: First, a rise in real oil price leads to productivity growth slowdown and unemployment increase at the scale of 16–64 months after 1990 for Japan and 8–24 months after 2005 for US. Second, an increase in real interest rate results in higher unemployment at the 16–32-month scale before 1974 for Japan and 8–64-month scale before 2000 for US. Third, the degree of integration between labour market and energy market in US is higher than that in Japan. This study provides time-frequency evidence to the supply side hypothesis about the relationships between input prices and unemployment.

The Impact of Foreign Direct Investment on Economic Growth: Nigeria Experience

This study investigated the impact of foreign direct investment on economic growth in Nigeria. Secondary source of data was employed in this study from 1986 to 2017 which were sourced from Central Bank of Nigeria Statistical Bulletin (2017) published in 2018 and World Development Indicator published in 2019. Descriptive and regression analyses were used as the estimation techniques. The findings of the study revealed that the coefficient value of LFDI is 0.633506 and its p-value is 0.0002 implying that a unit increase in LFDI will increase LGDP with the value of 0.633506. The coefficient value of RINTR is 0.004127 with p-value of 0.310 indicating that a unit increase in real interest rate will increase gross domestic product, but it is not significant. Also, LDI coefficient value is 1.758036 with p-value of 0.0688 implying that a unit increase in domestic investment will increase gross domestic product positively with the value of 1.758036 which is significant at 10% but not significant at 5% alpha level. The coefficient value of exchange rate is 0.835206 with the p-value of 0.0000 signifying that exchange rate is positive and significant to economic growth. It was concluded that foreign direct investment was positive and significant to economic growth of Nigeria while the domestic investment was also positive but not significant at 5% alpha level.

Globalization, Market Power, and the Natural Interest Rate

We argue that strong globalization forces have been an important determinant of global real interest rates over the last five decades, as they have been key drivers of changes in the natural real interest rate—i.e. the interest rate consistent with output at its potential and constant inflation. An important implication of our analysis is that increased competition in goods and labor market since the 1970s can help explain both the large increase in real interest rates up to the mid-1980s and—as globalization forces mature and may even go into reverse, leading to incrementally rising market power—its subsequent and protracted decline accompanied by lower inflation. The analysis has important implications for monetary policy and the optimal pace of normalization.

Effects of Financial Deepening on Saving Mobilization: Evidence from African Countries

Purpose:The purpose of this paper is to investigate the impact of financial deepening proxied by Broad Money Supply as a percent of Gross Domestic Product and Domestic Credit to Private Sector as a percentage of Gross Domestic Product on savings proxied by Gross Domestic Savings as a percent of Gross Domestic Product in Africa over the period 1998 – 2015 
 Design/methodology/approach: The study uses panel data of forty-two (42) countries in Africa over the period 1998 – 2015 and the system generalized method of moments dynamic panel estimation framework.
 Findings: The paper finds an insignificantly positive relationship between Broad money supply and Gross Domestic Savings in Africa. However, the impact of Domestic Credit to Private Sector was negative and significant. This results indicate that financial deepening has not stimulated domestic resource mobilization in Africa. However, growth in per capita income had a significantly positive impact on Gross Domestic Savings which is consistent with the life cycle theory, increase in real interest rate negatively affected Gross Domestic Savings while increase in age dependency reduced Gross Domestic Savings. 
 Practical implications: Policies should focus on deepening the financial sector since it has the tendency to impact positively on savings. Such polices should center on extending financial services to the rural areas through the provision of infrastructure such as roads, electricity as well as the development of innovative financial instruments that will attract the large informal sector. Reducing the fragmented nature of the market and the high transaction costs as well as balancing the dominance of the banking sector will help improve efficiency of the sector and consequently, its ability to mobilize resources. Pursuing growth-enhancing policies that focus on value addition to raw materials and the adoption of technology to ensue efficiency in production could result in higher productivity and consequently savings. Efforts should also focus on reducing interest rates since many Africans are net borrowers and thus increase in interest rate will increase the cost of borrowing which will have adverse impacts on savings.
 Originality/value: The paper offers significant value in shaping and improving the financial sector in Africa with the view to enhancing savings.

Money- Physical Capital Nexus: How Valid Is McKinnon Complementarity Hypothesis In Turkish Economy?

According to theory of financial liberalization that emphasizes money and physical capital complementarity, increase in real interest rate following liberalization leads to money demand and investment. Validity of this assumption, which is also known as McKinnon complementarity hypothesis, has been tested empirically for various countries undertaken financial liberalization policies. These empirical works shape the policies of countries with regard to their money demand, interest rate and investment. This study investigates the nexus between money demand, interest rate and investment size in Turkey by employing Bound test and ARDL approach over the period 1988Q1-2013Q4. Empirical analysis of this study hints that there is a limited complementary relationship between money and physical capital in Turkish economy.

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Policy of Inflation Targeting in the Presence of Fiscal Deficit and External Debt: Opt or Not to Opt.

The main task of the macroeconomic policy-makers is to control unemployment and inflation at the minimum possible level. Different policies have been tried to control inflation at its minimum possible level and inflation targeting is the most popular among them. It is the commitment to maintain inflation at the announced level and use interest rate as an instrument to control it if it is expected to diverge from the announced level. However in a higher \dollar denominated debt. country Central Bank is reluctant to increase interest rate because it pressurises the foreign exchange market, which leads to exchange rate depreciation. If there is exchange rate pass through effect to prices, depreciation leads to increase in prices. Thus increase in interest rate does not decrease prices instead results in increase in prices. The two important linkages were tested in this study are (i) increase in real interest rate depreciates the currency, and (ii) depreciation in real exchange rate leads to increase in prices. Using VAR model we concluded that real exchange rate is not significantly associated to the real interest rate in the short run and exchange rate pass through effect to prices is not present in Pakistan.

Exchange‐Rate‐based Stabilisation, Durables Consumption and the Stylised Facts

In this article we show that a model featuring durable consumer goods, imperfect substitution between domestic and foreign assets, and weak credibility can explain the qualitative and quantitative aspects of the stylised facts associated with exchange-rate-based stabilisation, including the tremendous increase in real interest rates. Following a temporary reduction in the crawl, total consumption spending rises 14–26%, the real exchange rate appreciates 20–37% and the current account deficit swells to 10–15% of gross domestic product. Despite large capital inflows, the real interest rate increases from 10 to 20–100%.

The Short-Run Macroeconomics of Aid Inflows: Understanding the Interaction of Fiscal and Reserve Policy

We develop a tractable open-economy new-Keynesian model with two sectors to analyze the short-term effects of aid-financed fiscal expansions. We distinguish between spending the aid, which is under the control of the fiscal authorities, and absorbing the aid-using the aid to finance a higher current account deficit-which is influenced by the central bank's reserves policy when access to international capital markets is limited. The standard treatment of the transfer problem implicitly assumes spending equals absorption. Here, in contrast, a policy mix that results in spending but not absorbing the aid generates demand pressures and results in an increase in real interest rates. It can also lead to a temporary real depreciation if demand pressures are strong enough to threaten external balance. Certain features of low income countries, such as limited participation in domestic financial markets, make a real depreciation more likely by amplifying demand pressures when aid is spent but not absorbed. The results from our model can help understand the recent experience of Uganda, which saw an increase in government spending following a surge in aid yet experienced a real depreciation and an increase in real interest rates.

Comment on: “Welfare implications of the transition to high household debt” by Campbell and Hercowitz

The purpose of Campbell and Hercowitz (2009) is to evaluate quantitatively the macroeconomic effects of deregulation of the mortgage market in the early 1980s. This deregulation made it easier for consumers to use houses as collateral for loans. The paper focusses on two questions. First, can this deregulation help to explain the increase in real interest rates in the early 1980s? Second, and more importantly, what effect did this deregulation have on household welfare? Campbell and Hercowitz do a good job of motivating their quantitative analysis, citing facts about changes in household debt and mortgage refinancing in the U.S. during the past quarter-century. The percentage of mortgagees who had ever refinanced their homes, for example, increased from 10% in 1983 to 44% in 2001, and housing equity as a fraction of house value (for newly purchased homes with a loan-to-value ratio of at least 50%) decreased from 23% of 1983 to 16% in 2001. Moreover, household debt increased from 43% of U.S. GDP in 1982 to 62% in 2000. Finally, throughout this period, homes and cars collateralized roughly 90% of household debt. These are big numbers that underscore the need for a coherent quantitative analysis of the macroeconomic effects of deregulation in the mortgage market. Campbell and Hercowitz do an excellent job of providing precisely such an analysis. The main findings of the paper are twofold. First, the sudden loosening of collateral (or, more generally, borrowing) constraints increases interest rates and lowers wages during the transition to a new steady state. Second, in a reasonably calibrated quantitative model, deregulation hurts borrowers: although they benefit directly from looser borrowing constraints, the indirect (general equilibrium) effect of deregulation on prices more than offsets these benefits, leading to a net welfare loss. Lenders, on the other hand, gain. I will use the bulk of the rest of my discussion to illustrate these effects in a drastically simplified version of Campbell and Hercowitz’s model. By stripping away extraneous details, this simplified version of their model suggests that the forces at work in Campbell and Hercowitz’s model are robust to changes in the exact details of how housing, housing debt, and mortgage financing are modelled. Moreover, even in this simple model there are opposing effects on household welfare, emphasizing again the need for a quantitative analysis such as Campbell and Hercowitz’s in order to measure their net effect.

Exchange-Rate-Based Stabilization, Durables Consumption, and the Stylized Facts

In this paper we show that a model featuring durable consumer goods, imperfect substitution between domestic and foreign assets, and weak credibility can explain the qualitative and quantitative aspects of the stylized facts associated with exchange-rate-based stabilization, including the tremendous increase in real interest rates. Following a temporary reduction in the crawl, total consumption spending rises 14-26%, the real exchange rate appreciates 20-37%, and the current account deficit swells to 10-15% of GDP. Despite large capital inflows, the real interest rate increases from 10% to 20-100%.

Fiscal Policy and Interest Rates

Since the Seventies, increases in public debt and deficits have raised concern about their effects on interest rates. Growing public debt and persistent deficits would have led to inflation pressures, which would have forced central Banks to raise the short-term interest rate. Expectations of these pressures by financial markets would involve a rise in long-term interest rates and crowding-out effects. This paper studies the fiscal policy effects on interest rates from a theoretical and empirical point of view. Fiscal policy effects mainly depend on the full-employment hypothesis, the type of shocks affecting the economy, the type of fiscal policy, and agents' expectations about it. The estimated effects of fiscal policy variables in central Banks' reaction functions and long-term interest rate equations for the United States, the United Kingdom, Germany and Japan for the 1980-2003 period show that these effects are not mechanical and vary from one country to another. All in all, fiscal policies would not have entailed a generalized increase in real interest rates over that period.

Libor Interest Rates

This paper presents a dynamic general equilibrium model that disentangles interbank interest rates from interest rates on government bonds. Firstly, I explicitly identify the externality in the financial sector that explains the use of cash in the portfolios of financial intermediaries. Cash provides insurance for the interest rate used to finance loans. However, when a financial intermediary decides his level of insurance, he ignores the negative effect of his decision on the remaining financial sector. It is shown that the positive spread between interbank rates and treasury rates is the leading variable that drives the money market. The spread has to increase when financial intermediaries desire less cash than the cash available in the economy. Similarly, the spread decreases when there is less cash in the economy than desired by financial intermediaries. Secondly, general equilibrium implications are analyzed. The externality creates an ex-ante distortion in the financial sector. As a result, borrowing interest rates have to increase relative to lending interest rates. The analysis is developed in a model where there are private investors, financial intermediaries and a government. The model is simple enough to allow close form solutions. I identify the role played by interbank rates that prevents them from reflecting a pricing kernel at which the real economy is willing to transfer cash flows over time, thereby compromissing the use of Libor interest rates in valuation. Additionally, an increase in expected inflation exarcebates the externality identified in this paper. As a consequence, expected inflation increases the equilibrium costs of financial intermediation. The result is an increase in real interest rates and an economic slowdown.

Financial Innovation, Market Participation, and Asset Prices

AbstractThis paper investigates the pricing effects of financial innovation in an economy with endogenous participation and heterogeneous income risks. The introduction of non-redundant assets endogenously modifies the participation set, reduces the covariance between dividends and participants' consumption and thus leads to lower risk premia. In multisector economies, financial innovation spreads across markets through the diversified portfolio of new entrants, and has rich effects on the cross-section of expected returns. The price changes can also lead some investors to leave the markets and give rise to non-degenerate forms of participation turnover. The model is consistent with several features of financial markets over the past few decades: substantial innovation, higher participation, significant turnover in investor composition, improved risk management practices, a slight increase in real interest rates, and a reduction in risk premia.

Shocks and Institutions in a Job Matching Model

This paper explains the divergent behavior of European and US unemployment rates using a job market matching model of the labor market with an interaction between shocks and institutions. It shows that a reduction in TFP growth rates, an increase in real interest rates, and an increase in tax rates leads to a permanent increase in unemployment rates when the replacement rates or initial tax rates are high, while no increase in unemployment occurs when institutions are 'employment friendly.' The paper also shows that an increase in turbulence, modeled as an increased probability of skill loss, is not a robust explanation for the European unemployment puzzle in the context of a matching model with both endogenous job creation and job destruction.

The effects of budget deficit on national saving in the OECD

In this paper, we estimate a structural VAR using a panel of OECD countries, which includes national saving and budget deficit, both as the ratio to GDP, to test the Ricardian Equivalence hypothesis. In this framework, we separate saving and deficit movements into two types of shocks, associated with structural parameters of these economies. Our results suggest that Ricardian Equivalence did not work in our sample of OECD countries, since private saving compensated only a small fraction budget deficit. This supports the interpretation that the large budget deficits have been a very important factor behind the significant increase in real interest rates in the eighties and early nineties.

An analysis of the optimal provision of public infrastructure: a computational model using Mexican data

We construct a intertemporal general equilibrium model and use it to examine infrastructure effects on Mexican national income. We consider three types of infrastructure, electricity, transportation, and communications. We then estimate production functions for the 16 major sectors of the economy in which sectoral output depends upon inputs of capital and labor, as well as the stocks of the three types of infrastructure. We then use these estimates to analyze the optimal level of government spending on the different types of infrastructure. Despite the fact that the estimated output elasticities with respect to public infrastructure are relatively high, increased expenditure on infrastructure has rapidly decreasing benefits. Some benefits could be achieved by modest increases in capital expenditures, although at the cost of significantly higher inflation and real interest rates. Indeed, the increase in real interest rates causes the benefits of enhance infrastructure to be greatly reduced.