Lagged Interest Rate Research Articles

Macroeconomics and the Spanish stock market, impact-response analysis

The aim of this paper is to identify potential causal relationships between macroeconomic variables and the stock market in Spain. Numerous articles recognize the influence of macroeconomic variables on the stock market and value this knowledge as essential for good investment management. However, there are very few empirical studies that justify the influence of disaggregated macroeconomic variables on the stock market in Spain and vice versa. This article uses the general index of the Madrid Stock Exchange as a proxy variable of the stock market and numerous macroeconomic variables, analyzing monthly data from January 2001 to December 2020 from various published data sources. A descriptive analysis is carried out and a vector autoregressive model (VAR) is applied. Finally, the causality is analyzed identifying the transmission of effects between them. The results confirm the impact of lagged interest rate, monetary aggregate M1 and unemployment rate on the stock market but also identify new features, such as the influence of the stock market on the interest rate, industrial production index, manufacturing activity index and economic sentiment index. This research is useful for Public Administration to detect possible risks in the economy, and it enables investors to better manage their investments.

Asymmetries in the monetary policy reaction function: evidence from India

Abstract This paper analyzes the reaction function of monetary authority in India from 1997Q 1 to 2019Q 4 using nonlinear Taylor rule. It has been found that monetary policy reaction function (MPRF) in India is asymmetric and is influenced by the state of the economy, determined by the lagged interest rate. To capture such asymmetry, we have used a set of nonlinear models including smooth transition regression (STR) model, threshold regression (TR) model and Markov-switching regression (MSR) model along with the instrumental variable estimation technique. The analysis discloses that the behaviour of the Reserve Bank of India (RBI) is asymmetric, reacts aggressively to output gap in general and particularly during periods of high interest rate. Furthermore, the RBI reacts more to inflation and output gap during low volatile regimes in MSR models compared to high volatile regimes. We also found that there is a high degree of inertia in the policy rates of the RBI. The study concludes that nonlinear models may not only help in understanding the behaviour of the RBI but also prevent from making incorrect and misleading conclusions in Indian context.

IS THE TUNISIAN CENTRAL BANK FOLLOWING A LINEAR OR A NONLINEAR AUGMENTED TAYLOR RULE?

The political transition in the Arab Spring countries has been accompanied by a deterioration of economic and financial indicators like in the Tunisian case. This paper aims to get a deeper understanding of the nature of the rule that reflects the behavior of the Tunisian monetary authority in the current dominance of economic and financial instability. In particular, this paper assesses whether the Tunisian Central Bank is indeed following a linear or a non linear augmented Taylor rule. For our purpose, we use a forward looking version of Taylor rule augmented by including the effect of exchange rate to estimate the linear and the nonlinear models. A smooth transition regression model is used to estimate the nonlinear rule. The results obtained imply that the Tunisian Central Bank follows a nonlinear Taylor rule in the conduct of monetary policy. In addition, our evidence suggests that the reaction of monetary authority in Tunisia to the deviation of forecasts of inflation rate, output gap and exchange rate changes in terms of magnitude and statistical significance across the high and low interest rate regimes. In particular, when the lagged interest rate is above the threshold level of 4.76%, the main objective of the policy makers is to fight the inflation rate and to limit the depreciation of exchange rate rather than to boost the economic activity.Keywords: Taylor rule, smooth transition regression model, interest rate reaction function, nonlinearityJEL Classifications: C22, E17, E43, E52, E58DOI: https://doi.org/10.32479/ijefi.8975

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IS THERE A “REVERSE CAUSALITY” FROM NOMINAL FINANCIAL VARIABLES TO ENERGY PRICES?

This paper is aimed at examining the association between energy prices and financial variables, but, in contrast to previous works, it explores the possibility of a reverse causality from financial variables towards energy prices from a global perspective considering the world’s four largest world economic poles (the United States, China, the European Union, and Japan), as well as the prices of oil (Brent) and Natural Gas. In order to study the interaction between energy prices and relevant nominal variables (stock market returns, interest rates, and exchange rates), a Panel Vector Autoregression Analysis (PVAR) is carried out. The empirical finding is that Brent Oil and Natural Gas price fluctuations are positively and highly significantly influenced by lagged interest rates, that is, energy markets are sensitive to monetary policy signals and, most likely, to economic agents’ expectations about inflation. Other empirical results also reveal that: 1) lagged exchange rate fluctuations have a negative and significant effect over the stock market; 2) a positive performance of the stock market has a negative effect on the exchange rate, and: 3) that interest rate markets follow their own dynamics independently of the rest of the model variables.

Money and business cycle: Evidence from India

In this paper we take a New Keynesian model with non-separable money in utility to Indian data using maximum likelihood. The identification problem in isolating the effect of money on output and inflation is solved by adjusting real balances for shifts in money demand. Estimates with an extended model with relevant features like partial indexation in prices, markup shock and time varying inflation target, show that real balances do affect output and inflation even after correcting for money demand unlike results for the United States and Eurozone. A regression estimate and multivariate structural vector autoregression give similar results. Types of money matter. Reserve money has the largest impact, pointing to the importance of the informal sector. The estimated income elasticity of narrow money is more than twice that of broad money, pointing to the dependence of firms on banks. Interest semi elasticity of money demand is close to one. Responsiveness of output to real interest rate is high. We find that interest rate setting is quite persistent. Coefficient of lagged interest rate varies from 0.71 to 0.95. We conclude that there is a significant asymmetry in the role of money in India (an emerging economy) in comparison to United States and Eurozone (advanced economies).

The threshold effect of monetary policy on earnings persistence

ABSTRACTThis paper employs panel smooth transition regression models with monetary policy proxies (interest rate and inflation rate) as the transition variables to estimate the earnings persistence of Taiwan’s companies. The impacts of monetary policy on the persistence of systematic earnings and unsystematic earnings are lagged and different, depending on monetary policy variables in different regimes. High lagged interest rates and lagged inflation rates increase the persistence of current unsystematic earnings and reduce the persistence of current systematic earnings. Specifying 1.315% as an inflation target level and providing an environment of high interest rates can maintain stable earnings persistence.

The Effect of Real-Time Fiscal Policy on Sovereign Interest Rates in OECD Countries

The aim of this study is to investigate the effect of real-time projections of fiscal policy stances on government bonds long-term interest rates using a panel of 20 OECD countries between 1992 and 2008. To deal with endogeneity arising from forecasts of fiscal balances the paper exploits instrumental variables and GMM estimators together with the variation in real-time primary balances. The study shows how a static specification that does not include the one-period lag of the interest rate is prone to serial correlation and to downward bias in standard errors. To correct the bias, a dynamic specification with the lagged interest rates used as explanatory variable should be used due to the intrinsic persistent behavior of the interest rates. Results show that when the persistency of the interest rates is taken into account, it corrects the bias in standard errors of the estimates, and the correlation between fiscal policy variables and sovereign rates disappears: the inertia of the behavior of interest rates is the only variable affecting the relation.

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The effect of real-time fiscal policy on sovereign interest rates in OECD countries

The aim of this study is to investigate the effect of real-time projections of fiscal policy stances on government bonds long-term interest rates using a panel of 20 OECD countries between 1992 and 2008. To deal with endogeneity arising from forecasts of fiscal balances the paper exploits instrumental variables and GMM estimators together with the variation in real-time primary balances. The study shows how a static specification that does not include the one-period lag of the interest rate is prone to serial correlation and to downward bias in standard errors. To correct the bias, a dynamic specification with the lagged interest rates used as explanatory variable should be used due to the intrinsic persistent behavior of the interest rates. Results show that when the persistency of the interest rates is taken into account, it corrects the bias in standard errors of the estimates, and the correlation between fiscal policy variables and sovereign rates disappears: the inertia of the behavior of interest rates is the only variable affecting the relation.

The zero lower bound on the interest rate and a Neoclassical Phillips curve

I derive the exact analytical solution for optimal monetary policy given a Neoclassical Phillips curve and a zero lower bound on the nominal interest rate. There is a particular range of interest rate rule parameters that may close the output gap. One way of closing the output gap involves stable but high inflation (the divine coincidence). In the general case inflation is variable and potentially lower. Thus, one can achieve stable OR low inflation, but not both. When the productivity shock has an unbounded support, only the variable inflation version of optimal policy is implementable. Optimal policy then involves a lagged interest rate response to shocks and a random walk price level.

Was it risk? Or was it fundamentals? Explaining excess currency returns with kernel smoothed regressions

This paper uses recently developed kernel smoothing regression procedures and uniform confidence bounds to investigate the forward premium anomaly. These new statistical methods estimate the local time-varying slope coefficient of the regression of spot returns on the lagged interest rate differential. Uniform confidence bands are used to test when uncovered interest parity is violated. The estimated betas in the forward premium smoothed regression are found to vary substantially over time and to be partially explicable in terms of lagged fundamentals and money growth volatilities arising from risk premium. Frequentist model averaging procedures indicate the relative importance of these variables in terms of explaining movements in the betas and hence the apparent causes of regimes where UIP fails.

Determining structural breaks in central bank reaction functions of the financial crisis

Determining breakpoints in central bank reaction functions is crucial to monitor the decisions of the governing councils correctly. This is especially true during the recent financial crisis. However, reaction functions do not necessarily change at the beginning of a crisis and so the specific breakpoints need to be estimated rather than being set exogenously. While central bank reaction functions typically include more than one exogenous variable it is possible that the breakpoints in the reaction coefficients change from one independent variable to the other. We develop an estimation strategy using real-time data that account explicitly for variable breakpoints in the different independent variables. Using Taylor reaction functions for the ECB and the Fed we show that there are indeed different breakpoints with respect to the lagged interest rate, the inflation rate and the output gap within the financial crisis, in which the reaction coefficients tend to be significantly lower. Out-of-sample forecasts underline the result of a less volatile reaction of central banks during the crisis period.

Monetary Policy and the Uncovered Interest Rate Parity Puzzle: Theory and Empirical Results for Oceania

This article offers a theory-based explanation for why high- interest-rate countries see their currencies appreciate, the so-called UIP puzzle. The central bank bases its target rule on the lag of the policy instrument and the CPI inflation rate. When combined with a stylised model of an open economy, the endogenous target rule can account for the systematic negative relation between the change in the exchange rate and the lagged interest rate differential. Foreign inflation and the foreign interest rate also affect nominal exchange rate changes. The model-based behaviour of the exchange rate is tested on New Zealand and Australian data with mixed results.

Taylor Rule Exchange Rate Forecasting during the Financial Crisis

Taylor Rule Exchange Rate Forecasting during the Financial Crisis

Interest Rate Rules and Money as an Indicator Variable

Interest Rate Rules and Money as an Indicator Variable The paper derives the monetary policy reaction function implied by using money as an indicator variable. It consists of an interest rate response to deviations of the inflation rate from target, to the change in the output gap, to money demand shocks and to the lagged interest rate. We show that this type of inertial interest rate rule characterises the Bundesbank's monetary policy from 1979 to 1998 quite well. This result is robust to the use of real-time or ex post data. The main lesson is that, in addition to anchoring long-term inflation expectations, money introduces inertia and history-dependence into the monetary policy rule. This is advantageous when private agents have forward-looking expectations and when the level of the output gap is subject to persistent measurement errors. (E43, E52, E58) Zinsregeln mit der Geldmenge als Indikatorvariable Das vorliegende Papier leitet die geldpolitische Reaktionsfunktion einer Zentralbank ab, wenn das Geldmengenwachstum als Inflationsindikator verwendet wird. Die resultierende Reaktionsfunktion umfasst eine Reaktion des Leitzinses auf Abweichungen der Inflationsrate vom Zielwert, auf Änderungen der Produktionslücke, auf Geldnachfrageschocks und auf den verzögerten Zinssatz. Wir zeigen, dass sich die Geldpolitik der Bundesbank von 1979 bis 1998 durch diese Art einer trägen Zinsregel gut abbilden lässt. Dies gilt unabhängig davon, ob die empirische Analyse auf Basis von Echtzeitdaten oder von revidierten Daten erfolgt. Die wichtigste Erkenntnis ist, dass die Orientierung am Geldmengenwachstum neben einer Verankerung der langfristigen Inflationserwartungen dafür sorgt, dass die geldpolitische Reaktionsfunktion träge und vergangenheitsabhängig ist. Beide Eigenschaften sind im Sinne von Robustheit vorteilhaft, wenn die Erwartungsbildung der privaten Wirtschaftssubjekte vorausschauender Natur ist und wenn die Echtzeitschätzungen der Produktionslücke persistenten Messfehlern unterliegen. (E43, E52, E58)

Monetary policy inertia: case of Jordan

PurposeThe purpose of this paper is to examine the inertia of monetary policy in the Jordanian economy, in which the monetary policy is neutral owing to the adoption of a fixed exchange rate with the US dollar. The question of the current paper is: Does monetary policy inertia exist in such an economy despite the fact that the exchange rate is pegged to a foreign currency?Design/methodology/approachTo test the hypothesis of the current paper in Jordan, the Taylor rule, adjusted to be consistent with the context of monetary policy in Jordan, is estimated. Moreover, the model is estimated by two techniques: OLS and the Kalman filter, using quarterly data over the period (1994:1‐2007:1).FindingsThe empirical evidence from the Jordanian economy shows that monetary policy inertia is highly significant in Jordan. The coefficient of the lagged interest rate is estimated to lie between 0.60 and 0.69. Moreover, the evidence illustrates that both inflation rate and output gap have an insignificant effect on setting the policy rate. Further, the policy interest rate seems to be set gradually in reaction to monetary policy inertia, unobserved variable and foreign interest rate.Originality/valueThe paper investigates monetary policy inertia in a developing country whose economy is small, widely open and has a fixed exchange rate with the US dollar.

Nonlinear interest rate reaction functions for the UK

We empirically analyze Taylor-type equations for short-term interest rates in the United Kingdom using quarterly data from 1970Q1 to 2006Q2. Starting from strong evidence against a simple linear Taylor rule, we model nonlinearities using logistic smooth transition regression (LSTR) models. The LSTR models with time-varying parameters consistently track actual interest rate movements better than a linear model with constant parameters. Our preferred LSTR model uses lagged interest rates as a transition variable and suggests that in times of recessions the Bank of England puts more weight on the output gap and less so on inflation. A reverse pattern is observed in non-recession periods. Parameters of the model change less frequently after 1992, when an inflation target range was announced. We conclude that for the analysis of historical monetary policy, the LSTR approach is a viable alternative to linear reaction functions.

Optimal Monetary Policy Under Financial Sector Risk

We consider whether or not a central bank should respond directly to financial market conditions when setting monetary policy. Specifically, should a central bank put weight on interbank lending spreads in its Taylor rule policy function? Using a model with risk and balance sheet effects in both the real and financial sectors (Davis, The Adverse Feedback Loop and the Effects of Risk in the both the Real and Financial Sectors Federal Reserve Bank of Dallas, Globalization and Monetary Policy Institute Working Paper No. 66, November 2010) we find that when the conventional parameters in the Taylor rule (the coefficients on the lagged interest rate, inflation, and the output gap) are optimally chosen, the central bank should not put any weight on endogenous fluctuations in the interbank lending spread. However, the central bank should adjust the risk free rate in response to fluctuations in the spread that occur because of exogenous financial shocks, but we find that the central bank should not be too aggressive in its easing policy. Optimal policy calls for a two-thirds of a percentage point cut in the risk free rate in response to a financial shock that causes a one percentage point increase in interbank lending spreads.

Policy Irreversibility and Interest Rate Smoothing

Many empirical studies argue that the inertial behavior of policy rates in industrialized countries can be well explained by a linear partial adjustment version of the Taylor rule. However, the explanatory power of the lagged interest rate has been questioned from various points of view. This paper formally examines a situation in which a central bank has an aversion to frequent policy reversals. Imposing an irreversibility constraint on the control space makes the lagged interest rate a state variable. However, the policy function cannot then be expressed as a partial adjustment form, even if the original Taylor rule would be the correct policy function in the absence of the irreversibility constraint. The simulation results reveal that conventional regression tends to falsely support the functionally misspecified partial adjustment model. This implies that the significant role of the lagged interest may simply reflect the central banks’ aversion to policy reversal.