Optimal Interest Rate Research Articles

The financing strategy of agricultural supply chain based on cost sharing and buyer guarantee is considered in smart agriculture

Supported by the agricultural technology, the intelligent agricultural development is flourishing. However, due to the high technology cost and investment risk, intelligent agriculture in China is still in the exploration stage. This article designs the appropriate cost sharing mechanism under the two-stage supply chain system, which composes of a farmer, a core enterprise and a commercial bank. With the comparison between commercial bank financing model and the buyer guarantees financing model, this paper researches the optimal decisions of supply chain members and the influence of the cost-sharing ratio, technical input gain effect and the buyer guarantees ratio. The results show that the profit will increase with the add of technical input gain effect. Besides, only under certain conditions, cost sharing is valuable to each member. Finally, numerical examples show existing an optimal interest rate spread area that all members would benefit from the buyer guarantee financing model.

How Much Better Is Commitment Policy Than Discretionary Policy? Evidence From Six Developed Economies

Abstract Much has been written on how an active central bank produces inflation outcomes above and beyond what commitment policy would produce. This paper contributes to this body of literature by simulating from the state estimates of both commitment and discretionary policy equilibria in a familiar dynamic New–Keynesian framework. Optimal interest rate and inflation rate policies are derived under the two regimes for six developed economies. The model is estimated using Bayesian methods employing a random-walk Metropolis–Hastings algorithm. Optimal inflation and interest rate policies for each of the economies are simulated. Results suggest that the simulated inflation induced by discretionary policy is not significantly different from commitment policy after 2000 for five of the six countries (including the U.S). Simulated commitment interest rate policy is on average 1.9% higher at the center of the distribution, suggesting that discretionary interest rate policy is on average more often loose compared to commitment interest rate policy. Simulations of the average inflation deviation and welfare loss of discretion policy indicate are greatest when the central bank exhibits low preference for inflation targeting and high preference for output stability.

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Optimal Quantitative Easing in a Monetary Union

This paper explores the optimal allocation of government bond purchases within a monetary union, using a two-region DSGE model, where regions are asymmetric with respect to economic size and portfolio characteristics: the extent of substitutability between assets of different maturity and origin, asset home bias, and steady-state levels of government debt. An optimal quantitative easing (QE) policy under commitment does not only reflect different region sizes, but is also a function of these dimensions of portfolio heterogeneity. By calibrating the model to the euro area, we show that optimal QE favors purchases from the smaller region (Periphery instead of Core), given that the former faces stronger portfolio frictions. A fully optimal policy consisting of both the short-term interest rate and QE lifts the monetary union away from the zero lower bound faster than an optimal interest rate policy alone, which entails forward guidance.

Optimal financing and operational decisions of capital-constrained manufacturer under green credit and subsidy

<p style='text-indent:20px;'>To stimulate the capital-constrained manufacturer to produce green products, the government often adopts two incentive mechanisms: green credit (i.e., subsidy offered directly to bank) and subsidy (i.e., subsidy offered directly to manufacturer). This paper examines the optimal interest rate of the bank, and the optimal product green degree and sales price of the manufacturer under the two mechanisms, respectively. Furthermore, we investigate the effects of these mechanisms on the optimal decisions, the profits of players, the social welfare and the environmental benefits. Several important results are obtained. First, when the total government subsidy is low, the green credit mechanism can bring the higher green degree, product sales price and demand, as well as higher profits for the bank and manufacturer, rather than the subsidy mechanism. Otherwise, the result is opposite. Second, the government should adopt the green credit mechanism to support the manufacturer to develop green products when the budget is limited and relatively low. If the government budget is sufficient, the subsidy mechanism is the best choice, which can bring higher economic and environmental benefits.

Business Cycles, Optimal Interest Rate, and Recession Forecast From Yield Curve, Unemployment, GDP, and Payrolls

We developed a factor regression model, nicknamed “GUPTY”, to study the business cycles, and their relation to the monetary policy. It covers several major macro-economic quantities, including unemployment rate, GDP, and weekly payrolls in the U.S. after WWII. The model postulates that these macro-economic quantities are predominantly a nonlinear function of the 10Y and 3M interest rates in the Treasury yield curve, and their regressions share similar model specification. The concept of the business cycle is injected into the model through the yield spread between 10Y and 3M rates. The notion of the natural rate of unemployment and GDP growth comes out of the model naturally. An optimization framework is proposed to determine the optimal short-term interest rate, which is a central concern for policymakers – Once the model parameters are obtained from regressions, the model is inverted to calculate the optimal 3M rate via optimization of the squared errors. Its first-order analytic solution is derived. We find that FED’s interest rate policy has leaned heavily on the unemployment data. We also observe that, on the optimality, the model GDP growth rate matches the realized data almost perfectly. We discuss some policy challenges, and attempt to provide an explanation for the plunge of GDP growth after 2009 due to super-low 10Y rate, in which the “2% GS10 floor hypothesis” is suggested. Unemployment’s 1Y momentum and its 6M acceleration are used to construct a Hidden Markov Model for real-time recession probability. Furthermore, a Random Forest model is developed to forecast recession up to 24 months ahead. And we show recession forecast is closely associated with yield spread inversion.

Impact of Loss-Aversion on a Financially-Constrained Supply Chain

Traditionally, in the area of production and operations management, the financial states and decision-makers’ behaviour regarding loss have been ignored in the supply chain, which may lead to infeasible or unrealistic practices or even catastrophic losses in practical supply chain operations. Therefore, this study aims to provide a model for operational efficiency in a financially constrained supply-chain system consisting of a financially deficient retailer, a supplier, and a bank, and to analyse the impact of the behaviour of the bank and the supplier on the operational decision. It is assumed that the bank provides a loan to the retailer considering the supplier’s credit guarantee for the retailer. The supplier’s credit guarantee implies that, if the retailer goes bankrupt after the sales season, then a pre-guaranteed proportion of the retailer’s loan is repaid by the supplier. Moreover, to capture the decision-makers’ behaviour regarding loss, it is assumed that the supplier and the bank are loss-averse in their risk preference on the final profit. Under this circumstance, it is intended to draw the theoretical implications by analysing a loss-averse behaviour model for a supplier and a bank, in which a kinked piecewise linear and concave utility function is considered. The optimal decision is analytically derived for the retailer (the optimal order quantity), the supplier (the optimal wholesale price), and the bank (the optimal interest rate). In addition, a sensitivity analysis is conducted to investigate how the model parameters affect the optimal decision for the retailer, the supplier, and the bank under different degrees of loss-aversion. The optimal decisions are shown to be highly affected by the degree of the loss-aversion coefficient of the bank and the supplier and to be more conservative than the result in the traditional case which optimises the risk-neutral expected profit (the unit degree of loss-aversion). The analytical results can be summarised as follows. First, as the wholesale price and the interest rate increase, the optimal order quantity decreases. Second, the more loss-averse the supplier is, the higher the optimal wholesale price that is offered to the retailer by the supplier. Third, the larger the credit guarantee that is provided to the retailer by the supplier, the higher the optimal wholesale price that is provided to the retailer. Fourth, the more loss-averse the bank is, the higher the interest rate that is offered to the retailer; and the larger the credit guarantee that is provided by the supplier, the lower the interest rate that is offered to the retailer.

Two resolutions of the margin loan pricing puzzle

This paper supplies two possible resolutions of Fortune’s (2000) margin-loan pricing puzzle. Fortune (2000) noted that the margin loan interest rates charged by stock brokers are very high in relation to the actual (low) credit risk and the cost of funds. If we live in the Black–Scholes world, the brokers are presumably making arbitrage profits by shorting dynamically precise amounts of their clients’ portfolios.First, we extend Fortune’s (2000) application of Merton’s (1974) no-arbitrage approach to allow for brokers that can only revise their hedges finitely many times during the term of the loan. We show that extremely small differences in the revision frequency can easily explain the observed variation in margin loan pricing. In fact, four additional revisions per three-day period serve to explain all of the currently observed heterogeneity.Second, we study monopolistic (or oligopolistic) margin loan pricing by brokers whose clients are continuous-time Kelly gamblers. The broker solves a general stochastic control problem that yields simple and pleasant formulas for the optimal interest rate and the net interest margin. If the author owned a brokerage, he would charge an interest rate of (r+ν)/2−σ2/4, where r is the cost of funds, ν is the compound-annual growth rate of the S&P 500 index, and σ is the volatility.

Consumer Search, Incomplete Exchange Rate Pass‐Through, and Optimal Interest Rate Policy

AbstractThis paper studies utility‐maximizing monetary policy in a two‐country economy with consumer search frictions. Search frictions provide a microfoundation for incomplete exchange rate pass‐through and international deviations from the law of one price (LOP). I show that optimal interest rate policy targets deviations from the LOP and acts to mitigate the effect of search frictions. In a quantitative setting, with internationally correlated technology and preference shocks, optimal policy generates positive cross‐country correlation of nominal interest rates.

Estimating Central Bank Reaction Functions Post 2008: USA and Switzerland

Almost all central banks worldwide have a common goal of keeping inflation low and stable while simultaneously maintaining the health of their country’s financial system. By studying the Swiss National Bank and the US Federal Reserve, this paper investigates whether a single model can be used to capture these two mandates – both in times of economic stability and in times of crisis.&#x0D; Ultimately, using differences between market interest rates as a "barometer of fears of bank insolvency" the model presented in this paper is able to detect when a crisis is occurring. Furthermore, it is able to describe the change in central bank behaviour associated with said crisis.&#x0D; The value of the model is in its simplicity, it only uses four macroeconomic variables to provide accurate forecasts. Furthermore, monetary economists are highly interested in simple models to determine the optimal interest rate. Such types of models are associated with the "Great Moderation" – a time period from the 1980s – 1990s where a reduction in the volatility of the business cycle was linked to a strict rule-based approach to monetary policy. Insight into these rules can ultimately improve the welfare of all citizens by allowing central banks to handle economic crises more effectively.&#x0D;

FX Intervention in the New Keynesian Model

We develop an open economy New Keynesian Model with foreign exchange intervention in the presence of a financial accelerator mechanism. We obtain closed-form solutions for the optimal interest rate policy and FX intervention under discretionary policy, in the face of shocks to risk appetite in international capital markets. The solution shows that FX intervention can help reduce the volatility of the economy and mitigate the welfare losses associated with such shocks. We also show that, when the financial accelerator is strong, the risk of multiple equilibria (self-fulfilling currency and inflation movements) is high. We determine the conditions under which indeterminacy can occur and highlight how the use of FX intervention reinforces the central bank’s credibility and limits the risk of multiple equilibria.

Optimal Monetary Policy and Term Structure in a Continuous-Time DSGE Model

We study optimal monetary policy, macro dynamics and their implications on the term structure of interest rates in a continuous-time New Keynesian model. With a quadratic cost function and regime-dependent monetary discount rates facing the central bank, the time-consistent optimal monetary policy is regime-dependent linear interest rate rules in inflation and output gaps. The optimal interest rate rules and the equilibrium dynamics of inflation and output gap form a regime-dependent term structure model. We take the model to the US data and find that the Fed had followed two distinct interest rate rules, one is not optimal while the other is near-optimal with a large monetary discount rate. The macro dynamics are more stable under the near-optimal policy rule than the non-optimal one.

Are Direct Investments by the Federal Reserve a Good Idea? A Corporate Finance Perspective

Due to the crisis of 2007–2009, financial friction macro models are being used to provide a theoretical foundation for the evaluation of ‘unconventional policy’. In these models, banks take deposits from households and lend to firms. Empirically, other financial channels that are missing in the models, such as corporate bonds and equity, are also important. This paper analyzes a model in which bank loans and equity are both feasible. Households have limited ability to enforce their claims. If either the bank or the equity market are undistorted, the equilibrium is socially efficient. If both are distorted, the equilibrium is inefficient. In that case, government policy aimed at the bank or at the firm can be helpful. Suitably chosen equity injections, loans, or interest rate subsidies can all work. Interest rate subsidies have the advantage that they occur later and there is less concern about cheating. Equity injections have the advantage that they minimize the necessary level of tax imposed on households that is needed to achieve optimality. Optimal equity injections and optimal loan subsidies induce reductions in household savings (‘crowding out’). Optimal interest rate subsidies induce increases in household savings (‘crowding in’).

Interbank Funding as Insurance Mechanism for (Persistent) Liquidity Shocks

The interbank market is important for the efficient functioning of the financial system, transmission of monetary policy and therefore ultimately the real economy. In particular, it facilitates banks' liquidity management. This paper aims at extending the literature which views interbank markets as mutual liquidity insurance mechanism by taking into account persistence of liquidity shocks. Following a theory of long-term interbank funding a financial system which is modeled as a micro-founded agent based complex network interacting with a real economic sector is developed. The model features interbank funding as an over-the-counter phenomenon and realistically replicates financial system phenomena of network formation, monetary policy transmission and endogenous money creation. The framework is used to carry out an optimal policy analysis in which the policymaker maximizes real activity via choosing the optimal interest rate in a trade-off between loan supply and financial fragility. It is shown that the interbank market renders the financial system more efficient relative to a setting without mutual insurance against persistent liquidity shocks and therefore plays a crucial role for welfare.

Inflation Persistence, Price Indexation and Optimal Simple Interest Rate Rules

We study the properties of the optimal interest rate rule under different sources of inflation persistence. In our model, the optimal policy minimizes price dispersion, which depends on the degree of price indexation. When indexation is zero, inflation persistence depends only on the level of trend inflation, the inflation gap is purely forward‐looking and the optimal policy targets inflation stability. Full indexation makes the inflation gap persistent, eliminates the effects of trend inflation and makes the optimal policy target the real interest rate. We compare our results with empirical estimates of the FED's policy in the post‐WWII era.

Interest Rates 7: An Optimal Rate of Interest (the Natural Rate)

This is the seventh in a series of seven papers on interest rates and it covers the Wicksell hypothesis, the general interpretation of it, an alternative interpretation, how the alternative interpretation is reconciled with the general interpretation, and its fit with the Taylor rule. A modification to the Taylor rule is discussed. The seven papers cover: (1) what are interest rates?; (2) relationship of interest rates; (3) composition of interest rates; (4) interest rate discovery; (5) bank liquidity & interest rate discovery; (6) role of interest rates; (7) an optimal rate of interest: the natural rate.

Interest Rates 3: Composition of Interest Rates

This is the third in a series of seven papers on interest rates and it covers the yield curve, the literature on the composition of interest rates, an alternative analysis of composition of interest rates, the literature on the risk-free rate, an alternative view of the risk-free rate, and an analysis of the relationship of interest rates. The seven papers cover: (1) what are interest rates?; (2) relationship of interest rates; (3) composition of interest rates; (4) interest rate discovery; (5) bank liquidity & interest rate discovery; (6) role of interest rates; (7) an optimal rate of interest: the natural rate.

Interest Rates 4: Interest Rate Discovery

This is the fourth in a series of seven papers on interest rates and it covers the principle of interest rate discovery and security valuation, the micro structure of financial markets, the role of secondary markets, interest rate discovery in the debt and deposit markets, and the micro factors which impact on price discovery. The seven papers cover: (1) what are interest rates?; (2) relationship of interest rates; (3) composition of interest rates; (4) interest rate discovery; (5) bank liquidity & interest rate discovery; (6) role of interest rates; (7) an optimal rate of interest: the natural rate.

Interest Rates 5: Bank Liquidity &amp; Interest Rate Discovery

This is the fifth in a series of seven papers on interest rates and it covers the monetary policy models, a bank liquidity analysis, the concept of quantitative easing in terms of a bank liquidity analysis, and how a QE policy affects interest rates. The seven papers cover: (1) what are interest rates?; (2) relationship of interest rates; (3) composition of interest rates; (4) interest rate discovery; (5) bank liquidity & interest rate discovery; (6) role of interest rates; (7) an optimal rate of interest: the natural rate.

Interest Rates 6: Role of Interest Rates

This is the sixth in a series of seven papers on interest rates and it covers the various roles of interest rates: primary tool of monetary policy, bridge between present and future consumption, advancing consumption / investment with debt, interest rates’ inverse relationship with asset prices and the wealth effect, the role of interest rates in derivative instrument pricing, and interest rates’ role in foreign sector issues. The seven papers cover: (1) what are interest rates?; (2) relationship of interest rates; (3) composition of interest rates; (4) interest rate discovery; (5) bank liquidity & interest rate discovery; (6) role of interest rates; (7) an optimal rate of interest: the natural rate.