Long-run Interest Rate Research Articles

The Long Memory of Equity Volatility: International Evidence

This paper examines long memory volatility in international stock markets. We show that long memory volatility is widespread in a panel dataset of eighty-two countries and that the degree of memory in the panel can be related to macroeconomic variables such as short- and long-run interest rates and unemployment. Moreover, we find that developed economies possess longer memory in volatility than emerging and frontier countries and that stock market jumps are negatively correlated with long memory of volatility. Overall, our results provide some evidence of a link between stock market uncertainty and macroeconomic conditions, which is prevalent across a large range of countries.

The Mexican Interest Rate Pass-Through in the Post-U.S. Subprime Mortgage Crisis Era

ABSTRACTThis study investigates the nature of the Mexican interest rate pass-through during the post-U.S. subprime mortgage crisis. The empirical results reveal a very high short-run and an almost complete long-run interest rate pass-through. The bounds test indicates a long-term relationship between countercyclical monetary policy and market rates. Notwithstanding the rigid inflation targeting set by the Mexican Central Bank in the very concentrated Mexican market and its openness to foreign competition, the Mexican open economy is very small compared to the U.S. economy. Despite these conditions, the Mexican Central Bank has been very effective in conducting its countercyclical monetary policy.

Productivity Growth and Interest Rate Trends: A Long-Run Analysis

This paper develops a new measure of after-tax rate of return on aggregate wealth and uses it in estimating the structural relationship between the long-run interest rate and productivity growth rate. The structural approach allows use of parameter estimates in constructing projections for the interest rate on U.S. Treasury securities. Results indicate that the long-run interest rate rises slightly more than one for one with productivity growth rate. The projected real interest rate on 10-year U.S. government bonds is in the 1.5-2.0 percent range under intermediate assumptions on future productivity growth and trends in the world interest rate.

Cross-Border Finance, Trade Imbalances and Competitiveness in the Euro Area

The nearly exclusive explanation for current account imbalances in the euro area blames real economy differences between countries, prominently the competitiveness of the participating states. This essay questions the common opinion that wage policy is crucial for rebalancing the European economies. This essay attempts to unfurl the real economy processes from the perspective of money and finance. This essay identifies an interregional asset-price-interest mechanism at work in the monetary union: A general change in the state of confidence provokes asset prices and the effective long-run interest rate to change and to affect aggregate demand and trade flows. A change in competitive positions of countries follows as the second-round effect. The policy implications prefer a downscaling of the financial sector against government interventions into wage formation.

Retail bank interest rate pass-through in the euro area: An empirical survey

This paper surveys the empirical literature on the retail bank interest rate pass-through in the euro area countries. We provide an in-depth discussion of the econometric issues challenging an appropriate assessment of the interest rate pass-through, such as unit root and structural break tests and asymmetry treatment. We offer an overview of the empirical evidence regarding the extent of the short-run and long-run interest rate pass-through and the adjustment dynamics of bank interest rates. We also provide insight into the state of monetary policy transmission more than 15 years after the introduction of the euro, and in the aftermath of the financial and sovereign debt crises.

One Size Does Not Fit All. A Non-Linear Analysis of European Monetary Transmission

This paper investigates the interest rate pass-through in eight European countries analyzing their short-run and long-run monetary transmission mechanisms. We investigate the relationship between the Euribor and the long-run interest rate on loans to non-financial corporations and allow for a mark-up which can be affected by country specific funding conditions and/or stochastic structural breaks. We detect significant differences across countries. Cointegration between the Euribor and the long-term bank loan interest rates holds for Germany, France, and the Netherlands, where banks seem to apply a constant mark-up. In the remaining countries of the sample the long-run pass-through is directly affected by changes in banks’ cost of funding, due to shifts in the spread between domestic and German long-term government bond interest rates. The selection of the country specific ESTAR/LSTAR parameterization of the short-run dynamics detects a high degree of heterogeneity. The transition variables vary from the government bond spreads, in countries which were involved in the European debt crisis via sovereign bond market contagion, to the VXO index and to the Euribor monthly volatility.

The impact of monetary policy on bank lending rate in South Africa

The pass-through of the policy rates to bank lending rate is an important subject matter because it measures the effectiveness of monetary policy to control inflation or stabilize the economy. This study investigates the long-run interest rate pass-through of the money market rate to the bank lending rate and asymmetric adjustment of the bank lending rate. The study applies the momentum threshold autoregressive and asymmetric error correction models. The asymmetric error correction results reveal that bank lending rate adjusts to a decrease in the money market rate in South Africa. The findings suggest that the South African commercial banks adjust their lending rate downward but the lending rate appears rigid upward, which supports the customer reaction hypothesis.

Systematic Policy and Forward Guidance at the Fed

The President of the Federal Reserve Bank of Philadelphia argues that the Federal Open Market Committee, by operating with a set of rules or guidelines and clearly stated objectives, could eliminate much of the second guessing about what it is doing and why, and the associated volatility in markets. The author's preference is that the FOMC formulate its policy as a �reaction function� that can be easily explained to the public. As an example of such a reaction function, he cites the proposal of Stanford economist John Taylor, whose �Taylor Rule� calls for setting the nominal fed funds rate based on three factors: (1) the economy's long-run real interest rate; (2) the deviation of inflation from the central bank's target or goal; and (3) an adjustment of the funds rate to departures of real GDP from some measure of �potential� GDP. Although many variations on Taylor's original recommendations could work, the author believes the FOMC should seek to develop a consensus on how it will react to future economic events. Even a qualitative description of such a reaction function would be a step forward. Taking such a systematic approach will improve the effectiveness of monetary policy in both normal times and more unusual or extreme circumstances, such as when policy is constrained by the lower zero bound on interest rates. The author also suggests that a recent (March 19) FOMC statement took a step in this direction when it moved to a qualitative form of forward guidance by stating that the Committee will be assessing progress�both realized and expected�toward its policy objectives.

Instability of Money Demand: Recent Evidence for Thailand

This study examines the short-run and long-run stability properties of money demand in Thailand using the monetary aggregates M1, M2 and M3, for the period from 1993Q1 to 2012Q4. We use the dynamic OLS specification of Stock and Watson (1993) and Ball (2001), and the estimation technique of the Johansen cointegration test to determine the stability of money demand. The results from the Johansen cointegration test reveal that there is only a long-run relationship between M1 money demand and real GDP (a proxy for real income) and interest rate. In the short run, only a change in real GDP affects M1 money holdings. In the long-run both real GDP and an interest rate determine money demand. The short-run instability of M1 money demand makes it difficult for the monetary authorities to use M1 as an intermediate target to control intermediate-run and long-run inflation.

AIG's announcements, Fed's innovation, contagion and systemic risk in the financial industries

We examine the effects of the American International Group, Inc.’s (AIG's) loss announcements and the Federal Reserve's subsequent innovation in the financial sector. Analysis of seemingly unrelated regression on the returns of four financial industries – banking, insurance, brokerage firms and savings and loan institutions (S&Ls) for the period 5 September 2007 to 31 December 2008 reveals that, the Federal Reserve's announcements on 16 September 2008 and on 8 October 2008 to pledge $85 billion and $37.8 billion, respectively, to save the AIG, have the most impact on the financial industries. All four industries are sensitive towards shocks in short- and long-run interest rate returns and market returns. We find evidence of significant contagion effect between insurance and banking industries and incremental systemic risk in all financial industries after the bailout by the Federal Reserve. We do not find any significant evidence supporting the Federal Reserve's perception of AIG to be too-big-to-fail.

Interest rate pass-through and illiquidity shocks in the US

This study examines the US interest rate pass-through mechanism and considers the illiquidity shocks upon retail interest rate correlations caused by financial crises between 1986 and 2011. We estimate a bi-variable EGARCH model using a dynamic conditional correlation model developed by Engle (2002) in order to analyze how asymmetric monetary policy influences interest rate pass-through. We test the risks to the dynamic condition and changes in the correlation coefficient. The main empirical results are as follows. First, the long-run interest rate pass-through mechanism is unstable in the US. Second, expected monetary policy impulses are greater than the unexpected ones in the short-run. Finally, according to the one-step and N-step forecast tests, the illiquidity shocks caused by financial crises demonstrate a significant change in retail interest rate risks, but not in correlations between retail interest rates. We conclude that when the interest rate pass-through mechanism is unstable, banks may stop helping each other and will not provide loans to firms and consumers, thereby exhausting the capital of all economic systems. The characteristics of illiquidity enter into the interest rate pass-through mechanism; therefore, the relationship between illiquidity and the interest rate pass-through needs to be investigated.

House Price Determinants: Fundamentals and Underlying Factors

This study examines the key drivers of real house prices in the five main Euro area countries (Germany, France, Italy, Spain, and the Netherlands) and the Anglo–Saxon economies (the United Kingdom and the United States) from 1970 to 2010. Estimating the determinants of house prices is very important, as they significantly influence economic activity and financial stability. Therefore, a multivariate unobserved component model, introduced by Harvey, has been used to model house price fluctuations. This technique allows us to catch those price movements that are not fully explained by economic fundamentals. The empirical results, in fact, indicate that in addition to changes in real income, long-run interest rates, stock prices and inflation, the latent component has a significant role in explaining real house prices. The latent component reflects those factors that are not specifically observed, such as structural changes in markets and changing preferences.

The dynamic interactions among the stock, bond and insurance markets

This paper explores the lead–lag relationships and the dynamic linkages among stock, insurance and bond markets in the developed countries. This is the first empirical study which sheds light on the extent and magnitude of the association among these financial markets used by the Granger causality test of Toda and Yamamoto (1995), generalized impulse response approach, and generalized variance decomposition in a multivariate setting. Our empirical results illustrate that there are indeed various patterns of dynamic relationships. The direction of causality appears to differ across countries. While investigating these interactive relationships under unexpected shocks, there is a one-way significant influence between the life insurance premium and long-run interest rate. These empirical findings serve as valuable applications not only for investors to diversify their risk away as well as to earn the abnormal return, but also for policy-makers to allocate resources more efficiently.

The Austerity Paradox: I See Austerity Everywhere, But Not in the Statistics

The core thesis of the paper is that taking a close look at the actual statistics available from Eurostat on the PIIGS-countries plus Cyprus, one finds little empirical evidence that the governments there have de facto reduced their total public expenditures. This is in stark contrast to the current austerity debate, which seemingly implicitly assumes that austerity has occurred over the past couple of years since the global Great Economic Crisis broke out in 2008. Therefore the author calls this empirical finding the austerity paradox. Many critics of the austerity policy of the current EU-member countries turn to this fact a blind eye. They point to the paradox of thrift as Keynes has named the contradiction that attempts to bring down a public deficit accomplished the opposite. Hayek instead pointed out the opposite weaknesses related to extensive public deficit spending and extreme low nominal interest rates which leads to significant malinvestments in end, since the long-run interest rate will sooner or later return to its long-term market value. Furthermore the paper gives empirical evidence about the outcomes of the ECB monetary support given to the crisis countries combined with the EFSM/EFSF/ESM together with the IMF as has been recently made public by the ECB and the German Ministry of Finance. These data show that a significant amount of debt refinancing of the PIIGS-countries just now is done by these channels at very low interest rates. Therefore the bailout of the crisis countries has already led and will even more lead so in the future to a transfer union of the Euro area based on Eurobonds issued by the respective emergency lenders. On top of this now the ECB since last August promised to buy unlimited amounts of debt of member countries, which would make it very unlikely that austerity in the sense of lower public spending will occur in the PIIGS-countries in the foreseeable future. More likely is debt forgiveness for the PIIGS-countries at some time in the future as for Greece in a first step has already been done before. This contradicts the official interpretation that austerity is the primary source for the current high unemployment and recession in these countries.

El canal de transmisión de las tasas de interés en la política monetaria de México

This paper aims to determine empirically the main transmission channels between short-term and long-run interest rates in the Mexican economy. Econometric results, obtained from a structural cointegrated VAR model, point out two clearly defi ned channels of transmission. Moreover, monopolistic credit institutions in the local market appear to play a fundamental role in the transmission mechanism of interest rates.

Policy rate pass-through and the adjustment of retail interest rates: Empirical evidence from Malaysian financial institutions

The paper examines the interest rate pass-through from money market rates to various retail rates in Malaysia within the framework of an error-correction model. We estimate the short- and long-run interest rate pass-through and analyse the asymmetric behaviour of financial institutions under different monetary regimes. The results show that both deposit and lending rate pass-throughs are incomplete. However, pass-through and speed of adjustment vary across financial institutions and retail rates. This analysis also shows that interest rate adjustments are asymmetric, with more significant adjustments taking place under monetary easing than under monetary tightening. These results provide support for the existence of the interest rate channel of monetary policy in Malaysia. There is thus a need to conduct effective monetary operations to support efficient monetary transmission in Malaysia.

Persistent Liquidity Effects and Long-Run Money Demand

We present a monetary model with segmented asset markets that implies a persistent fall in interest rates after a once-and-for-all increase in liquidity. The gradual propagation mechanism produced by our model is novel in the literature. We provide an analytical characterization of this mechanism, showing that the magnitude of the liquidity effect on impact, and its persistence, depend on the ratio of two parameters: the long-run interest rate elasticity of money demand and the intertemporal substitution elasticity. The model simultaneously explains the short-run “instability” of money demand estimates as well as the stability of long-run interest-elastic money demand. (JEL E13, E31, E41, E43, E52, E62)

A revisit on real interest rate parity hypothesis – simulation evidence from efficient unit root tests

A set of unit root tests are applied to test the existence of long-run real interest rate parity among the G-10 countries over the period 1971M1 to 2007M2. Rather than trusting the asymptotic distributions, this article uses simulation techniques to establish the small sample distributions of these tests, conditional on the stationary and nonstationary processes. The empirical results indicate that the tests have stable finite-sample sizes and higher size-adjusted powers such that the two estimated processes can be distinguished from each other. Thus, for six of the nine countries, their series are more likely to come from the estimated Autoregressive (AR) stationary process than from the nonstationary process. Noticeably, the testing results are rather different from those using the asymptotic distributions, in which only three countries support the real interest rate parity.

The impact of asset prices and their information value for monetary policy

En este articulo exploramos la aparente contribucion de los precios de los activos en las fluctuaciones de la economia y la inflacion, y por lo tanto, en la politica economica, usando un amplio panel internacional para el periodo comprendido entre 1970 y 2008. Demostramos que los precios de la vivienda son importantes para determinar la actividad economica y la politica monetaria, pero que los precios del mercado bursatil, aunque ofrecen informacion sobre muchos periodos, tienen una relacion menos significativa y definida. Adicionalmente, encontramos que los efectos son asimetricos durante el curso del ciclo economico. Usando una Regla de Taylor ampliada demostramos tambien que la politica monetaria no ha reaccionado significativamente a los precios de los activos, pero que las tasas de interes a largo plazo se ven claramente afectadas por la inflacion de los precios inmobiliarios. Las relaciones tienden a ser mas debiles en los ultimos anos, probablemente como resultado de una mayor estabilidad en el crecimiento de la produccion y la inflacion. Sin embargo, nuestros resultados sugieren que los bancos centrales deberian considerar los precios de los activos en las decisiones relacionadas con la politica monetaria.

The long-run uncovered interest rate parity in view of a trading strategy

The long-run uncovered interest rate parity in view of a trading strategy