Interest Rate Cuts Research Articles

Investors and dividend yields

This paper examines investor preferences for holding stocks with different dividend yields in a low market interest rate environment. Using a unique dataset reflecting the ultimate stock ownership in publicly traded Swedish firms, we examine if different categories of investors have specific preferences for dividends and the size of the dividend yield. We find that domestic institutional investors, unlike foreign investors, have higher holdings in stocks with a high dividend yield. Using multivariate analysis, we document that stock portfolios with dividend-paying stocks outperform those with non-dividend-paying stocks. After controlling for the size of the dividend yield, we obtain mixed results involving stock performance for dividend-paying stocks and the results indicate no strong difference in the period following cuts in market interest rates.

Russia’s Monetary Policy in 2018

Russia’s central bank adopted a new monetary policy regime in 2018 by raising the key interest rate for the first time since December 2014. After slashing the key interest rate on February 9th and on March 23rd by 0.25 percentage points to 7.5 and 7.25 percent per annum, respectively, the central bank lifted the rate on September 14th by 0.25 percentage points to 7.5 percent per annum, with another hike on December 14th of 0.25 percentage points to 7.75 percent per annum. The transition to a neutral monetary policy regime slowed as far back as in 2017. There were more constraints to interest rate cuts in 2018 that came from new April and August anti-Russia sanctions that spurred capital outflows from the country and depreciation of the Russian ruble, a VAT hike decision scheduled for 2019, a late-year fall in energy prices, and concerns about possible heightening of inflation expectations. The key interest rate hike suggested that the Bank of Russia is committed to bring inflation back down to target in the medium term. For instance, according to a forecast of the central bank, end-of-year inflation for 2019 may reach 5–5.5 percent, and it is not until 2020 that inflation is back to its target.

No One Left Behind in Indonesia?

Indonesia is maintaining economic growth at 5% per annum, with the country holding the mantle of the world’s most stable economic growth since 2002. However, trade flows contracted in the first half of 2019, and ongoing international trade frictions have created a challenging external environment. Inflation remains within the target range, and Bank Indonesia has, like other central banks, moved to cut interest rates. Urban air pollution is an increasingly prominent issue, with Jakarta’s air quality index frequently reaching unhealthy levels in mid-2019. President Joko Widodo has announced an intention for the government to build a new national capital city in East Kalimantan, a plan that would involve substantial costs if it were to go ahead.The president has used the phrase ‘No one left behind’ in prioritising inclusivity in the development process in line with the United Nations’ Sustainable Development Goals (SDGs). We review Indonesia’s considerable progress in broadening residential access to modern energy, developing the case for a new ‘beyond electrification’ agenda and renewed efforts in improving access to clean cooking. We also focus on the status of three groups with members who face marginalisation from full participation in society: the disabled, the elderly and the unemployed. Steps are being taken to establish and broaden targeted assistance for members of each of these groups. Nevertheless, there is a long way to go in reducing the extent to which marginalised members of society are left behind.

South Africa – Interest Rate Cut

South Africa – Interest Rate Cut

The Stochastic Lower Bound

Since the Great Recession policy rates have been extremely low, but neither absolutely constant, nor exactly set to zero. We thus augment a standard Zero Lower Bound (ZLB) model to study the effects of a Stochastic Lower Bound (SLB) on policy rates. We find that a less predictable SLB reduces the deflationary effects of negative demand shocks by lowering expectations of future values of the SLB at times when interest-rate cuts are not an option.

Macroeconomic Policy Beyond Brexit

Macroeconomic Policy Beyond Brexit

Monetary Regime Choice and Optimal Credit Rationing at the Official Rate: The Case of Russia

Stabilizing monetary policy in a small open economy is constrained by the open economy trilemma. In a crisis this constraint may not allow the Central Bank to cut interest rates because this may cause significant capital flight and the ensuing problems. In this paper we investigate whether the Central Bank’s credit rationing at the official rate (CROR) may soften the open economy trilemma constraint and improve the results of monetary policy for different monetary regimes. We construct a DSGE model appropriate for analysing the forward-looking behaviour of households facing a non-zero probability of credit rationing at the official rate. A simulation of estimated on a Russian data model and welfare optimization exercises allow us to contribute to the question of optimal monetary regime choice and to analyse the role of credit rationing for different monetary regimes.We have found significant credit rationing in the quarterly Russian data of 2001-2014. The share of liquidity constrained (non-Ricardian) households and the probability of CROR are estimated as 22% and 66% respectively. Welfare maximization exercises reveal a trade off between low-inflation and high-welfare solutions and favour of a floating exchange rate regime. Researching CROR gives mixed results. On the one hand we found the optimal value of the probability of CROR in both exchange rate-based and Taylor rule-based models. On the other hand the resulting improvement in welfare is very small.

Central bank hawks unlikely to gain the ascendancy

▀ Although further financial market weakness could delay or scale back central bank tightening this year, the waters are being muddied by the perception that underlying inflation pressures are building and that past exceptional measures to counter downside risks may no longer be needed. On balance, we think that it is more likely that central banks will push back, rather than bring forward, rate hikes, especially if the recent oil price weakness persists. ▀ The most crucial issues for the path of monetary policy are likely to be the outlook for inflation and the risks to growth prospects. While there may be grounds to reverse past ‘insurance’ cuts in interest rates, only a slow pace of normalisation is justified at present, in our view. In Europe in particular, sustained lowflation remains a risk. ▀ Central banks may develop a taste for raising rates if they perceive the neutral interest rate to be trending up. There may also be a desire to normalise policy to create space for future loosening, but this will only affect policy at the margin. Meanwhile, although problems such as banking troubles and the zombification of firms are often blamed on low interest rates, they are probably more a symptom of low growth and other more structural issues. Raising interest rates is unlikely to resolve these problems. ▀ At the margin, central bank behaviour may become less dovish. However, with the global economy slowing and some recession warning indicators flashing amber, the wings of the hawks will likely remain clipped.

Commitment and Borrower Heterogeneity: Evidence from Revolving Consumer Credit

Based on a unique dataset provided by a retail bank, we analyze borrower heterogeneity in the debt response to interest rate decreases and credit limit increases in revolving consumer credit. Our key findings show that 1) the debt response of borrowers who commit to monthly minimum repayments is about four times as large as the response of uncommitted borrowers when interest rates decrease, 2) committed borrowers demand credit limit increases which are more than twice as high as those of uncommitted borrowers following interest rate cuts, and 3) committed borrowers' marginal propensity to consume out of credit limit increases is almost 30% stronger. These results are most likely to be caused by sophisticated present-biased individuals choosing to commit and shed new light on the role of non-standard borrower preferences in consumer credit.

Frictions in transmission of interest rate cuts from central bank to commercial banks in India. An enquiry

This paper is an attempt to understand the interest rate adjustments made by the Indian commercial banks in accordance with central bank adjustments. The process followed is that of building a reaction function with respect to base rate of a bank. The findings of the study show that focusing on the base rate fixation by State Bank of India in different quarters, the base rate in the immediate past quarter, the current as well as the net interest income of the past few quarters and provisioning for loan losses in the current quarter plays a significant role in their decisions on base rate adjustments. The implications of the findings of the present study for policy makers is significant as the good health of the banking sector with minimal amount of nonperforming assets will impart the much needed flow to monetary transmission in India.

Frictions in transmission of interest rate cuts from central bank to commercial banks in India. An enquiry

Frictions in transmission of interest rate cuts from central bank to commercial banks in India. An enquiry

The Arguments for a Permanent Zero Interest Rate.

A zero interest rate regime is one where government issues a form of money which pays no interest, but does not borrow. There are three reasons for that policy. First , most if not all the reasons given for government borrowing are hopeless. Second , adjusting interest rates is a policy which is riddled for anomalies. E.g. in order to be able to cut interest rates, government first has to artificially raise them. But artificial adjustments to the price of anything, including the price of borrowed money does not make economic sense. Third , the market failure which causes recessions is not the failure of interest rates to fall. It’s the failure of wages and prices to fall, which would increase the real value of base money and government debt (if there is any), which in turn would encourage spending. That’s the “Pigou effect”. If government and central bank were simply to create new base money and spend it (and/or cut taxes) in a recession, that would come to much the same as the Pigou effect. That is what might be called a “free market compliant” policy. Interest rate adjustments are not “compliant”. Thus government should not borrow other than for very good reasons, if there are any, and artificial adjustments to interest rates should cease, except perhaps in emergencies. That, for want of a better phrase, can be described as a “permanent zero interest rate” policy. That policy is not far from the UK Labour Party’s new fiscal rule.

Unconventional Monetary Policies in the Euro Area, Japan, and the United Kingdom

The global financial crisis hit hard in the euro area, the United Kingdom, and Japan. Real GDP from peak to trough contracted by about 6 percent in the euro area and the United Kingdom and by 9 percent in Japan. In all three cases, central banks cut interest rates aggressively and then, as policy rates approached zero, deployed a variety of untested and unconventional monetary policies. In doing so, they hoped to restore the functioning of financial markets, and also to provide further monetary policy accommodation once the policy rate reached the zero lower bound. In all three jurisdictions, the strategy entailed generous liquidity support for banks and other financial intermediaries and large-scale purchases of public (and in some cases private) assets. As a result, central banks’ balance sheets expanded to unprecedented levels. This paper examines the experience with unconventional monetary policies in the euro zone, the United Kingdom, and Japan. The paper starts with a discussion of how quantitative easing, forward guidance, and negative interest rate policies work in theory, and some of their potential side effects. It then reviews the implementation of unconventional monetary policy by the European Central Bank, the Bank of England, and the Bank of Japan, including a narrative of how central banks responded to the crisis and the evidence on the effects of unconventional monetary policy actions.

Negative Interest Rate Policy and Yield Curve

We extract the market's expectations about the ECB's negative interest rate policy from the euro area's yield curve and study its impact on the yield curve. To capture the rich dynamics taking place at the short end of the yield curve, we introduce two policy indicators that summarise the immediate and longer-horizon future monetary policy stances. The ECB has cut interest rates four times under zero. We find that the June 2014 and December 2015 cuts were expected one month ahead but that the September 2014 cut was unanticipated. Most interestingly, the March 2016 cut was expected four months ahead of the actual cut.

Regional Heterogeneity and the Refinancing Channel of Monetary Policy*

We argue that the time-varying regional distribution of housing equity influences the aggregate consequences of monetary policy through its effects on mortgage refinancing. Using detailed loan-level data, we show that regional differences in housing equity affect refinancing and spending responses to interest rate cuts, but these effects vary over time with changes in the regional distribution of house price growth. We build a heterogeneous household model of refinancing with mortgage borrowers and lenders and use it to explore the monetary policy implications arising from our regional evidence. We find that the 2008 equity distribution made spending in depressed regions less responsive to interest rate cuts, thus dampening aggregate stimulus and increasing regional consumption inequality, whereas the opposite occurred in some earlier recessions. Taken together, our results strongly suggest that monetary policy makers should track the regional distribution of equity over time.

Zero Lower Bound on Deposit Rates and Transmission Mechanism of the Negative Interest Rate Policy

There have been heated debates on the negative interest rate policy (NIRP) since it was first introduced in major economies. Critics argue that deposit interest rates cannot break through the zero lower bound (ZLB) and that banks’ interest margins can be heavily squeezed under the NIRP. The underlying rationale is that deposits are the source of funding for banks. In this paper, we argue that in the modern credit money system, banks create deposits by making loans, and not the other way around. Deposit rates can be sufficiently negative without hurting banks’ profitability or curbing credit supply. We use a dynamic stochastic general equilibrium (DSGE) model to demonstrate the quantitative importance of ZLB on deposit rates in the transmission mechanism of monetary policy. Simulation results show that the ZLB on deposit rates heavily impede the transmission mechanism of the NIRP, which might explain the limited effects of the NIPR in the Euro Area and Japan. If banks are willing to expose retail depositors to negative interest rates, the effectiveness of the NIRP will be greatly strengthened and central banks should adopt deeply negative interest rates during a deflationary recession. The transmission mechanism of an NIRP has not been exactly the same as conventional interest rate cuts. Banks’ profitability is still a major concern, and the central banks that implement the NIPR only take modest action. Negative interest rates have not reached retail depositors and the effects of the NIRP are limited. We present a DSGE model to show that sticky deposit rates have impeded the transmission channel of the NIRP. This result explains the limited effects of the NIRP in Japan and the Euro Area. We challenge the prevailing view that banks cannot pass on negative policy rates to retail deposits. If the interest rate pass-through to deposit markets is complete, the NIRP is very effective in boosting credit growth and inflation. Given that natural interest rates in advanced economies have stayed low, central banks may resort to the NIPR more often in the future. When the ZLB is no longer a constraint, to raise the inflation target, as heatedly debated, is not a necessary move anymore.

Financial Crisis: The Capture of Central Banks by the Financial Sector?

This article analyzes the question of whether central bank capture by the financial sector has increased in the aftermath of the financial crisis beginning in 2007. According to the Public Choice theory, this is inevitable: The financial sector has an increased incentive to capture the central bank for interest rates hikes, inter alia, to prevent inflationary pressures from unconventional monetary policies. On the contrary, for the Post-Keynesian democratic school, this is likely but not inevitable because central bank capture is a complex phenomenon depending on a contest between several actors. The relative ability of the financial sector to affect central bank interest rates, and in which direction it desired to do so, can be time varying. Motivated by profitability, the financial sector can be interested in either interest rate hikes or cuts. This article investigates empirically this theoretical debate for the period from January 1999 to December 2016 for the European Central Bank’s Governing Council, the Federal Reserve’s Board of Governors, and the Monetary Policy Committee of the Bank of England. We participate in this debate first by constructing, as standard in the literature, an F index indicating the ratio of central bankers with financial career background. Secondly, we test empirically the competing hypotheses on the capture of the central bank interest rate by estimating its relationship with our F index. Results are more favorable to the democratic school.

Implications of negative interest rate policies: An early assessment

AbstractOver the past few years, several central banks have implemented negative interest rate policies (NIRP) to provide additional monetary policy stimulus. This paper presents an early assessment of the domestic and global implications of NIRP by analysing the behaviour of a set of key financial variables. We report three main results. First, since the introduction of NIRP, many of the key financial variables have evolved broadly, as implied by the standard transmission channels. For the euro area, the responses of these financial variables following NIRP announcements are directionally consistent with those of conventional interest rate cuts. Second, NIRP could pose risks to financial stability but there is no conclusive evidence as yet of a significant impact on bank profitability or of a broad‐based increase in leverage. Third, the responses of assets of emerging market and developing economies to NIRP announcements are on average broadly consistent with those to other types of expansionary monetary policy measures.

Monetary Policy and Bank Equity Values in a Time of Low Interest Rates

This paper examines the effects of monetary policy on the equity values of European banks. We identify monetary policy shocks by looking at changes in the EONIA one-month and two-year swap contract rates during narrow windows around the press statements and press conferences announcing monetary policy actions taken by the ECB. We find that an unexpected decrease of 25 basis points on the short-term policy rate increases banks’ stock prices by about 1% on average. These effects vary substantially over time; in particular, they were stronger during the crisis period and reversed during the recent period with low and even negative interest rates. That is, with rates close to or below zero, further interest rate cuts became detrimental for banks’ equity values. The composition of banks’ balance sheets is important in order to understand these effects. In particular, the change in sensitivity to interest rate surprises as rates drop to low and negative levels is much more pronounced for banks with a high reliance on deposit funding, compared to other banks. We argue that this pattern can be explained by a reluctance of banks to pay negative interest rates on retail deposits. JEL Classification: E52, E58, G21

The Stochastic Lower Bound

Since the Great Recession policy rates have been extremely low, but neither absolutely constant, nor exactly set to zero. We thus augment a standard zero lower bound model to study the effects of a stochastic lower bound (SLB) on policy rates. We find that a less predictable SLB helps keep inflation closer to target by lowering expectations of future values of the SLB when interest rate cuts are not an option.