Interest Rate Peg Research Articles

Monetary Policy Interactions: The Policy Rate, Asset Purchases, and Optimal Policy with an Interest Rate Peg

Monetary Policy Interactions: The Policy Rate, Asset Purchases, and Optimal Policy with an Interest Rate Peg

What Is in a Name? Purchases and Sales of Financial Assets as a Monetary Policy Instrument

AbstractThis paper studies optimal interest rate and balance sheet policy in a quantitative New Keynesian model with a constrained financial sector, considering commitment versus discretion in monetary policy design and fixing either instrument. Optimal interest rate policy under commitment (discretion) achieves 93.0% (82.6%) of the potential gains to dual instrument monetary policy under commitment. Optimal discretionary dual instrument policy eliminates the cost of commitment limitations and exhibits no inflationary bias. Under commitment, the optimal balance sheet policy eliminates the cost of suboptimal interest rate policy, for example, an interest rate peg. Finally, I compare optimal policies to implementable rules‐based policies.

Interest Rate Deregulation and the Performance of Deposit Money Banks in Nigeria from 1989-2020

The research examined interest rate deregulation and the performance of deposit money banks in Nigeria for the period of 1989-2020. The objective of the study is to examine the impact of interest rate deregulation on the performance of deposit money banks in Nigeria and to examine the causal relationship between interest rate deregulation and performance of deposit money banks in Nigeria. The estimation output of the research shows a positive relationship between interest rate and bank performance in Nigeria measured by Total Assets of Deposit money banks in Nigeria. The coefficient of determination (67%) also shows above average explanatory power of the independent variables on the dependent variable. The results of the study show a long and short run relationship between the dependent variable (Total Assets) and the independent variables (Interest rate, inflation rate, loans and advances). The result also shows unidirectional causality between Total Assets and Loans and Advances. The research recommended among others that the CBN should consider not frequently changing the MPR (monetary policy rate) and CRR (Cash reserve ration) which most of the time influence interest rate peg of the deposit money banks.

The effects of capacity reduction policy under the interest rate peg in China

Capacity reduction has been a recurrent theme in China's economic policy. The central government takes various administrative measures to remove excess capacity, accumulated mainly due to underpriced production factors and distorted incentives. I evaluate the de-capacity policy in a series of models and prove that its effects depend critically on its persistence and monetary policy regime. Under an interest rate peg, a transient policy that changes markup temporarily is ineffective and even expansionary, whereas a persistent policy is effective due to a negative wealth effect. A permanent de-capacity policy can lead to over-reactions in macro variables because the interest rate peg adds positive feedback to the economy. Therefore, the de-capacity policy has greater uncertainty under the interest rate peg. As a policy tool, it easily deviates from its target and brings about excessive volatility. However, long-run price stability and a gradually advanced de-capacity policy are conducive to the achievement of policy targets.

Monetary Policy Interactions: The Policy Rate, Asset Purchases, and Optimal Policy with an Interest Rate Peg

Monetary Policy Interactions: The Policy Rate, Asset Purchases, and Optimal Policy with an Interest Rate Peg

E-stability vis-à-vis determinacy in regime-switching models

This paper examines E-stability, determinacy, and indeterminacy in a general class of regime-switching models with lagged endogenous variables. Using determinacy conditions from Cho (2016, 2020), our first result extends McCallum (2007) to models with time-varying parameters: the unique mean-square stable equilibrium is E-stable if agents have current information and one-period-ahead decision rules. Further, we address the existence of E-stable non-fundamental equilibria, and find that Iteratively E-stable equilibria of indeterminate switching models can exist. Finally, we show that indeterminate New Keynesian models with persistent, recurring interest rate peg regimes admit Iteratively E-stable equilibria. In special cases, the Iterative E-stability condition coincides with the Long Run Taylor Principle.

A New Daily Federal Funds Rate Series and History of the Federal Funds Market, 1928-1954

This article describes the origins and development of the federal funds market from its inception in the 1920s to the early 1950s. We present a newly digitized daily data series on the federal funds rate from April 1928 through June 1954. We compare the behavior of the funds rate with other money market interest rates and the Federal Reserve discount rate. Our federal funds rate series will enhance the ability of researchers to study an eventful period in U.S. financial history and to better understand how monetary policy was transmitted to banking and financial markets. For the 1920s and 1930s, our series is the best available measure of the overnight risk-free interest rate, better than the call money rate which many studies have used for that purpose. For the 1940s-1950s, our series provides new information about the transition away from wartime interest-rate pegs culminating in the 1951 Treasury-Federal Reserve Accord.

Option Pricing: Channels, Target Zones and Sideways Markets

After a market downturn, especially in an uncertain economic environment such as the current state, there can be a relatively long period with a sideways market, where indexes, stocks, etc., move in channels with support and resistance levels. We discuss option pricing in such scenarios, in both cases of unattainable as well as attainable boundaries, and obtain closed-form option pricing formulas. Our results also apply to FX rates in target zones without interest rate pegging (USD/HKD, digital currencies, etc.).

Option Pricing: Channels, Target Zones and Sideways Markets

After a market downturn, especially in an uncertain economic environment such as the current state, there can be a relatively long period with a sideways market, where indexes, stocks, etc., move in channels with support and resistance levels. We discuss option pricing in such scenarios, in both cases of unattainable as well as attainable boundaries, and obtain closed-form option pricing formulas. Our results also apply to FX rates in target zones without interest rate pegging (USD/HKD, digital currencies, etc.).

Interest Rate Pegging, Fluctuations, and Fiscal Policy in China

This paper proves in a New Keynesian model that interest rate pegging can explain the unusual business cycle fluctuations in China. It is traditional wisdom that when the nominal interest rate is inflexible, there is no unique equilibrium in macroeconomic models. We prove that a unique equilibrium exists if the nominal rate is pegged for a limited period, after which it switches to a flexible rate regime. The peg alters the propagation of external shocks, magnifies volatility of endogenous variables, and leads to instability of the economy. Besides, the model becomes more unstable when the peg duration extends, and when the pegged rate deviates from steady state. At the same time, fiscal multiplier increases under the peg, indicating fiscal policy may be more effective in mitigating economic fluctuations when monetary policy is restricted by interest rate pegging.

Interest Rate Pegs and the Reversal Puzzle: On the Role of Anticipation

We revisit the reversal puzzle: A counterintuitive contraction of inflation in response to an interest rate peg. We show that it is intimately related to the degree of agents' anticipation. If agents perfectly anticipate the peg, reversals occur depending on the duration of the peg. If they do not anticipate the peg, reversals are absent. In the case of imperfect anticipation, implemented by a Markov-switching framework, we measure the degree of anticipation by the frequency of the peg regime. Even if the frequency of the peg takes on a value twice as large as empirically observed, the reversal puzzle is absent.

The power of forward guidance in a quantitative TANK model

We quantify the macroeconomic effects of interest rate forward guidance in an estimated medium-scale Two-Agent New Keynesian (TANK) model. Although TANK models can in principle dampen or amplify the power of forward guidance compared to a representative agent model, our estimates indicate a dampening, as there is sufficient countercyclical redistribution. An interaction of forward guidance with asset purchases gives rise to non-linear effects that depend on the horizon of the interest rate peg.

Ramsey Optimal Policy versus Multiple Equilibria with Fiscal and Monetary Interactions

We consider a frictionless constant endowment economy based on Leeper (1991). In this economy, it is shown that, under an ad-hoc monetary rule and an ad-hoc fiscal rule, there are two equilibria. One has active monetary policy and passive fiscal policy, while the other has passive monetary policy and active fiscal policy. We consider an extended set-up in which the policy maker minimizes a loss function under quasi-commitment, as in Schaumburg and Tambalotti (2007). Under this formulation there exists a unique Ramsey equilibrium, with an interest rate peg and a passive fiscal policy.

Spending Reversals and Fiscal Multipliers under an Interest Rate Peg

AbstractThis paper examines whether fiscal stimuli are more effective when the monetary policy is less responsive to inflation. First, we provide empirical evidence suggesting that, in the period of U.S. passive monetary policy, a positive government spending shock was followed over time by a spending cut. Second, our theoretical analysis reveals that the pegged nominal interest rate is not a sufficient condition to generate a large fiscal multiplier. An increase in government spending could increase the long‐run real interest rate, if it is associated with a government spending reversal and a less responsive monetary policy. Consequently, the response of private consumption can be negative and the government spending multiplier is not necessarily greater than 1.

Seven Fallacies Concerning Milton Friedman's "The Role of Monetary Policy"

This paper analyzes Milton Friedman's (1968) article "The Role of Monetary Policy," via a discussion of seven fallacies concerning the article. These fallacies are: (1) "The Role of Monetary Policy" was Friedman’s first public statement of the natural rate hypothesis. (2) The Friedman-Phelps Phillips curve was already presented in Samuelson and Solow's (1960) analysis. (3) Friedman's specification of the Phillips curve was based on perfect competition and no nominal rigidities. (4) Friedman’s (1968) account of monetary policy in the Great Depression contradicted the Monetary History's version. (5) Friedman (1968) stated that a monetary expansion will keep the unemployment rate and the real interest rate below their natural rates for two decades. (6) The zero lower bound on nominal interest rates invalidates the natural rate hypothesis. (7) Friedman's (1968) treatment of an interest-rate peg was refuted by the rational expectations revolution. The discussion lays out the reasons why each of these seven items is a fallacy and infers key aspects of the framework underlying Friedman’s (1968) analysis.

Uncertainty About QE Effects When an Interest Rate Peg is Anticipated

After hitting the lower bound on interest rates, the Eurosystem engaged in a public sector purchase programme (PSPP) and forward guidance (FG). We use prior and posterior predictive analysis to evaluate the importance of parameter uncertainty in an analysis of these policies. We model FG as an anticipated temporary interest rate peg. The degree of parameter uncertainty is considerable and increasing in the length of FG. The probability of being able to reset prices and wages is the most important factor driving uncertainty about inflation. In contrast, variations in financial intermediaries' net worth adjustment costs have little impact on in ation outcomes.

Seven Fallacies Concerning Milton Friedman's 'The Role of Monetary Policy'

This paper analyzes Milton Friedman's (1968) article \The Role of Monetary Policy, via a discussion of seven fallacies concerning the article. These fallacies are: (1) \The Role of Monetary Policy was Friedman?s first public statement of the natural rate hypothesis. (2) The Friedman-Phelps Phillips curve was already presented in Samuelson and Solow's (1960) analysis. (3) Friedman's specification of the Phillips curve was based on perfect competition and no nominal rigidities. (4) Friedman?s (1968) account of monetary policy in the Great Depression contradicted the Monetary History's version. (5) Friedman (1968) stated that a monetary expansion will keep the unemployment rate and the real interest rate below their natural rates for two decades. (6) The zero lower bound on nominal interest rates invalidates the natural rate hypothesis. (7) Friedman's (1968) treatment of an interest-rate peg was refuted by the rational expectations revolution. The discussion lays out the reasons why each of these seven items is a fallacy and infers key aspects of the framework underlying Friedman?s (1968) analysis.

Pegging the Interest Rate on Bank Reserves: A Resolution of New Keynesian Puzzles and Paradoxes

We develop a model of monetary policy with a simple departure from the basic New Keynesian (NK) model. In this model, the central bank sets independently the interest rate on bank reserves and the nominal stock of bank reserves. Because reserves reduce the costs of banking, the model delivers local-equilibrium determinacy under a permanent interest-rate peg. As a result, it does not share the puzzling and paradoxical implications of the basic NK model under a temporary interest-rate peg (e.g., in the context of a liquidity trap). More specifically, it offers a resolution of the forward-guidance puzzle, a related puzzle about fiscal multipliers, and the of flexibility, even for an arbitrarily small departure from the basic NK model (i.e., arbitrarily small banking costs). It still solves or attenuates these puzzles and paradox for a vanishingly small departure, and also solves the of toil in that case. This limit result provides an equilibrium-selection device in the basic NK model, and brings this canonical sticky-price model at par with its sticky-information counterpart in terms of their ability to solve or attenuate the four puzzles and paradoxes.

Pegging the Interest Rate on Bank Reserves

We develop a model of monetary policy with a small departure from the basic New Keynesian (NK) model. In this model, the central bank can set the interest rate on bank reserves and the nominal stock of bank reserves independently, because these reserves reduce the costs of banking (i.e., have a convenience yield). The model delivers local-equilibrium determinacy under a permanent interest-rate peg. Consequently, it does not share the puzzling and paradoxical implications of the basic NK model under a temporary peg (e.g., in the context of a liquidity trap). More specifically, it offers a resolution of the forward guidance puzzle, a related puzzle about fiscal multipliers, and the paradox of flexibility, even for an arbitrarily small departure from the basic NK model (i.e., arbitrarily small banking costs and convenience yield of reserves).

Interest-Rate Pegs, Central Bank Asset Purchases and the Reversal Puzzle

We analyze the macroeconomic implications of a transient interest-rate peg in combination with a QE program in a non-linear medium-scale DSGE model. In this context, we re-examine what has become known as the reversal puzzle (Carlstrom, Fuerst and Paustian, 2015) and provide an analytical explanation for its appearance. We show that the puzzle is intimately related with agents' expectations. If, for instance, agents do not anticipate the peg, the reversal does not appear. The same is true if agents' inflation expectations are influenced by a monetary authority which follows a price-level-targeting rule instead of a standard Taylor rule. In this case, sign reversals do not occur even for very long durations of pegged nominal interest rates.