Long-term Nominal Interest Rates Research Articles

International effects of quantitative easing and foreign exchange intervention

A two-country general equilibrium model is developed to study the global consequences of quantitative easing and foreign exchange intervention. The model incorporates financial frictions such as limited commitment, differential pledgeability of assets as collateral, and a low supply of collateralizable assets. Due to differential asset pledgeability, financial intermediaries acquire different asset portfolios particular to their home country. Quantitative easing can reduce long-term nominal interest rates, mitigate financial frictions globally, and depreciate the currency of the country that supplies more pledgeable assets. The international effects of foreign exchange intervention depend on the implementing country. If implemented by the country that supplies more pledgeable assets, such intervention can ease financial frictions and enhance welfare globally.

Chinese Slowdown and the Nominal Term Structures of the U.S. and German Interest Rates

To measure the global spillovers of a Chinese slowdown on the long-term nominal interest rates in the US/Germany, I model the US/German nominal term structure jointly in the post financial crisis (FC) sample, including the Chinese leading indicator as a new factor. I use an affine term structure model and decompose changes in the 5-year nominal interest rates into (1) changes in the expected future nominal short rate, “the signaling channel,” and (2) the 5-year term premium, “the portfolio balance channel.” A drop in the Chinese leading indicator results in a significant drop in the US/German growth over the first year. In the US, this leads to clear signaling effects but no portfolio balancing effects. In Germany, I find both signaling and portfolio balancing effects, but the direction of these effects is opposite to what one might expect. To deal with the different monetary regimes since the Sovereign debt crisis (SDC) I also model the German term structure independently from the US in the post SDC sample. Like in the US, I now find that in Germany, a lower Chinese leading indicator has important signaling effects in the expected direction. However, (opposite) portfolio balancing effects neutralize these signaling effects on the estimated 5-year Bund yield.

Safe Asset Shortages and the Nominal Term Structure of U.S. Interest Rates

I use an affine term structure model with unspanned macro variables to investigate the importance of high Chinese growth before the financial crisis and low Chinese growth following the crisis for the U.S. long-term nominal interest rates. Before the financial crisis, a higher Chinese nominal growth increases Chinese foreign reserves, mainly in the form of the U.S. Treasuries, and decreases the estimated five-year Treasury yield by signaling the lower expectations of the U.S. nominal short rate. The effect of the Chinese nominal growth on the U.S. nominal term structure is the sum of the effects of the Chinese leading indicator and inflation. These empirical findings are important to understand the secular decline of long-term nominal interest rates in the U.S. before the financial crisis. After the financial crisis, the lower Chinese real growth lowers the estimated five-year Treasury yield mainly by lowering the estimated five-year Treasury term premium and to a lesser extent by signaling the lower U.S. future nominal short rate. I measure the effect of the Chinese real growth on the U.S. nominal term structure with the Chinese leading indicator after I control for the inflation. Lower Chinese real growth contributes to understanding the unusually low long-term nominal interest rates in the U.S. after the financial crisis.

Do fiscal spending news shocks generate financial spillovers?

This paper shows the US fiscal spending news shocks – identified using the Survey of Professional Forecasters – drive the Canadian long-term nominal interest rates. The news shocks explain about 10% of the Canadian long-term interest rate at business cycle frequencies.

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Inflation targeting and interest rates: a panel time-series approach

Inflation Targeting (IT) can be expected to play a role in structurally reducing nominal interest rates by lowering a country’s inflation expectations and risk premium. Relying on a panel of 52 advanced and emerging economies from 1975–2009, we carry out a formal investigation of this hypothesis. Our econometric strategy adopts a flexible and efficient panel estimation framework, controlling for a number of issues usually neglected in the literature, such as parameter heterogeneity and cross-section dependence. The empirical analysis is based on a dynamic model. Our findings are supportive of a view that, on average, IT leads to a reduction of short- and long-term nominal interest rates.

International long-term yields and monetary policy in a small open economy: The case of Canada

The objective of this study is to identify the impact of the recent period of international integration of bond markets on interest rates in a small open economy. The empirical methodology captures a financial globalization regime with a nonlinear, structural vector autoregression (SVAR) and a regime-switching contemporaneous interest-rate block. The responses of longer term interest-rate spreads in Canada to changes in U.S. long-term nominal interest rates are found to have increased by about one-third in the globalization regime since the late 1990s, consistent with recent research on the effects of international long-term yields on those in small open economies. There is also some evidence of a weaker response of the longer term spreads, a measure of the stance of policy in Canada, to the monetary policy rate in the globalization regime. However, the evidence does not support an important decoupling of short- and long-term interest rates that has made the monetary transmission mechanism less effective for controlling economic activity and inflation. In fact, monetary policy appears to have become even more effective in the globalization regime as result explicit inflation targeting.

2014 Triennial Surveillance Review - External Study - Integrating Bilateral and Multilateral Surveillance on a Continuing Basis

Overall the Fund has done a good job anticipating possible problems in each of the cases being examined here, which for shorthand we will label Fed tapering, Abenomics, China growth risks, and German fiscal policy. Moreover, the messaging has been broadly consistent across the Fund’s diverse range of products including multilateral surveillance products (e.g., the World Economic Outlook and the Global Financial Stability Report), bilateral products (including especially Article IV country reports), and the Fund's various new exercises aimed at proactively identifying risks, especially those of global systemic significance. The messaging is consistent in the sense that differences across products can mostly be explained by differences in timing, approach and emphasis, understanding that the problems involved are profoundly difficult with no one clear answer, much less a one-size-fits-all answer. Various modalities are listed and briefly summarized in the appendix to this report. The extent to which the Fund’s analysis has weaknesses is largely related to political and market sensitivities, particularly in dealing with large influential members. For example, we will raise concerns about whether the Fund was forceful enough in pointing out possible risks posed by the U.S. Federal Reserve’s third round of quantitative easing (QE III), initiated in September 2012, and whether it was forceful enough in advocating structural reforms (e.g., tax reform) that might have helped support long-term U.S. growth and helped soften spillover effects to other countries. In the case of Japan, the Fund was understandably quite supportive of Abenomics. But should it have worried about the financial stability risks if rising inflation expectations led to proportional (or greater) rises in long-term nominal interest rates in Japan? Given that the initial impulse of Abenomics was a large depreciation in the yen, should the Fund have placed even greater emphasis on “third arrow” structural reforms as an assurance that Abenomics would have a lasting long-term positive global impact, and not just short-term competitive effects? In the case of China, the Article IV reports were in fact quite alert to potential problems, and the 2013 report even incorporated results from a working paper on the global effects of a hard landing in China over the

Inflation Expectations and the News

This paper provides new evidence on the importance of inflation expectations for variation in nominal interest rates, based on both market-based and survey-based measures of inflation expectations. Using the information in TIPS breakeven rates and inflation swap rates, I document that movements in inflation compensation are important for explaining variation in long-term nominal interest rates, both unconditionally as well as conditionally on macroeconomic data surprises. Daily changes in inflation compensation and changes in long-term nominal rates generally display a close statistical relationship. The sensitivity of inflation compensation to macroeconomic data surprises is substantial, and it explains a sizable share of the macro response of nominal rates. The paper also documents that survey expectations of inflation exhibit significant comovement with variation in nominal interest rates, as well as significant responses to macroeconomic news.

Inflation Expectations and the News

This paper provides new evidence on the importance of inflation expectations for variation in nominal interest rates, based on both market-based and survey-based measures of inflation expectations. Using the information in TIPS breakeven rates and inflation swap rates, I document that movements in inflation compensation are important for explaining variation in long-term nominal interest rates, both unconditionally as well as conditionally on macroeconomic data surprises. Daily changes in inflation compensation and changes in long-term nominal rates generally display a close statistical relationship. The sensitivity of inflation compensation to macroeconomic data surprises is substantial, and it explains a sizable share of the macro response of nominal rates. The paper also documents that survey expectations of inflation exhibit significant comovement with variation in nominal interest rates, as well as significant responses to macroeconomic news.

On the 'Great Disconnect' between Stock Returns and GDP Growth Forecast Errors: Implications for Interdisciplinary Capital Markets Research in Accounting

Using consensus forecasts from the Philadelphia Fed’s Survey of Professional Forecasters, I find that the univariate association between stock returns and GDP growth forecast surprises is indistinguishable from zero. I consider two non-mutually exclusive hypotheses for this phenomenon. The first hypothesis is that GDP growth forecast surprises are correlated with offsetting cash flow news and discount rate news. The second hypothesis is that GDP growth forecast surprises measure news about economic growth with noise. Using Easton’s et al. (2002) implied cost of capital procedure along with Li and Mohanram’s (2014) cross-sectional earnings forecasts, I extract a measure of discount rate news at the stock market level and find evidence consistent with the first hypothesis. A key implication is that researchers interested in the valuation of news about economic growth need to account for the impact of contemporaneous movements in the discount rate. From an implementation standpoint, my study shows that changes in implied cost of capital estimates offer a comprehensive measure of discount rate news capturing not only procyclical variation in the long-term nominal interest rate but also countercyclical variation in the otherwise unobservable equity risk premium.

Long-term interest rates, risk premia and unconventional monetary policy

We study two kinds of unconventional monetary policies: announcements about the future path of the short-term rate and long-term nominal interest rates as operating instruments of monetary policy. We do so in a model where the risk premium on long-term debt is, in part, endogenously determined. We find that both policies are consistent with unique equilibria, that, at the zero lower bound, announcements about the future path of the short-term rate can lower long-term interest rates through their impact both on expectations and on the risk premium and that long-term interest rate rules perform as well as, and at times better than, conventional Taylor rules. With simulations, we show that long-term interest rate rules generate sensible dynamics both when in operation and when expected to be applied.

The term structure of interest rates and inflation forecast targeting

This paper examines the implications of the expectations theory of the term structure of interest rates for the implementation of inflation targeting. We show that the responsiveness of the central bank’s instrument to the underlying state of the economy is increasing in the duration of the long-term bond. On the other hand, an increase in duration will make long-term inflationary expectations - and therefore also the long-term nominal interest rate - less responsive to the state of the economy. The extent to which the central bank is concerned with output stabilisation will exert a moderating influence on the central bank’s response to leading indicators of future inflation. However, the effect of an increase in this parameter on the long-term nominal interest rate turns out to be ambiguous. Next, we show that both the sensitivity of the nominal term spread to economic fundamentals and the extent to which the spread predicts future output, are increasing in the duration of the long bond and the degree of structural output persistence. However, if the central bank becomes relatively less concerned about inflation stabilisation the term spread will be less successful in predicting real economic activity.

Hauptrefinanzierungszins, Interbankenmarkt und Geldangebot im Euroraum

Summary In macroeconomic models, the nominal money supply, the long-term nominal interest rate, or even the inflation rate usually serves as the monetary policy variable. In practice, however, none of these variables is directly controlled by the central bank. Consequently, these models do not accurately reflect the implementation of monetary policy. Based on a theoretical model which incorporates the main institutional features of the euro area, this paper analyzes the transmission of monetary policy impulses from their implementation (setting the interest rate at which banks can obtain liquidity from the central bank) via the interbank market to the aggregate money and credit supply in an economy. Building on this analysis, we discuss the ability of the central bank to steer its operating target, the interbank market interest rate, and the money supply.

The yield curve in a small open economy

Long-term nominal interest rates in a number of inflation-targeting small open economies have tended to be strongly correlated with those of the United States. This observation has recently led support to the view that, in these economies, the long-end of the yield curve has decoupled from its short-end and naturally to a concern that monetary policy may have lost some of its autonomy. We set up and estimate a two-country small open economy model in which the expectations hypothesis and uncovered interest rate parity hold to study the co-movement of long-term nominal interest rates of different currencies. We show that differences in the persistence of domestic and foreign disturbances, a hypothesis for which we find support in recent data, can explain the observed pattern of correlations. These correlations are not evidence of weaker monetary policy.

The Euro-Dividend: Public Debt and Interest Rates in the Monetary Union

The ongoing massive fiscal policy stimulus triggered increasing concerns on the potential impact on interest rate levels, as economic theory predicts. Particularly, the deterioration of some EMU countries’ fiscal positions has been putting at risk Eurozone’ financial stability. In this paper, we estimate a Panel VAR (PVAR) model on the EMU area employing annual data from 1970 to 2008 in order to assess the qualitative and quantitative impact of public debt on interest rates Our results show that prior to the introduction of the Euro an increase in public debt led to positive and significant effect on long-term nominal interest rates, with a stronger effect for high-debt countries. After the introduction of the single currency, the effect vanishes (in line with Bernoth 2004). We interpret this result as a confirmation of the crucial role of the monetary union in weakening the automatic risk-premium-based channel between debt shocks and returns on government bond.

The Impact of High and Growing Government Debt on Economic Growth: An Empirical Investigation for the Euro Area

This paper investigates the average impact of government debt on per-capita GDP growth in twelve euro area countries over a period of about 40 years starting in 1970. It finds a non-linear impact of debt on growth with a turning point—beyond which the government debt-to-GDP ratio has a deleterious impact on long-term growth—at about 90-100% of GDP. Confidence intervals for the debt turning point suggest that the negative growth effect of high debt may start already from levels of around 70-80% of GDP, which calls for even more prudent indebtedness policies. At the same time, there is evidence that the annual change of the public debt ratio and the budget deficit-to-GDP ratio are negatively and linearly associated with per-capita GDP growth. The channels through which government debt (level or change) is found to have an impact on the economic growth rate are: (i) private saving; (ii) public investment; (iii) total factor productivity (TFP) and (iv) sovereign long-term nominal and real interest rates. From a policy perspective, the results provide additional arguments for debt reduction to support longer-term economic growth prospects. JEL Classification: H63, O40, E62, E43

Do Monetary Policy Transparency, Independence and Credibility Enhance Macro- Financial Stability?

It is generally agreed that the credibility, independence and transparency of the central bank have produced better overall policy outcomes and reduced the financial market uncertainty. This paper, using panel data approach, evaluates the effect of, respectively, the central bank transparency, independence and credibility on, respectively, the level and variability of realized and expected economic performance. It also analyzes the effects of central banks characteristics on the level and variability of Government bond rate. The results obtained suggest that central bank independence does not influence the realized and expected level and variability of economic performance. As for the central bank transparency, our findings are consistent with the view that greater transparency could have a desirable reputational effect that lowers inflation expectations and long-term nominal interest rates. Finally, our results show that central bank credibility negatively influences the level and variability of Government bond rate.

Does inflation targeting really make a difference? Evaluating the treatment effect of inflation targeting in seven industrial countries

We evaluate the treatment effect of inflation targeting in seven industrial countries that adopted this policy in the 1990s. To address the self-selection problem of policy adoption, we make use of a variety of propensity score matching methods recently developed in the treatment effect literature. Our results show that inflation targeting has no significant effects on either inflation or inflation variability in these seven countries. Further evidence from long-term nominal interest rates and income velocity of money also supports the window-dressing view of inflation targeting.

Should Monetary Policy Use Long-Term Rates?

This paper studies two roles that long-term nominal interest rates can play in the conduct of monetary policy in a New Keynesian model. The first allows long-term rates to enter the reaction function of the monetary authority. The second considers the possibility of using long-term rates as instruments of policy. In both cases a unique rational expectations equilibrium exists. Reacting to movements in long yields does not improve macroeconomic performance as measured by the loss function. Long-term rates, however, turn out to be better instruments of monetary policy than short-term rates when the concern for inflation volatility is high.