Role Of Interest Rates Research Articles

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 & 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 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 1: What are Interest Rates?

This is the first in a series of seven papers on interest rates and it covers the basic terms and information required for a fuller understanding of the significance of interest rates: the instruments that interest rates apply to, the bank interest margin which plays an important transmission role in monetary policy, time value of money, types, relationship between rates and prices, and other relevant 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.

Interest Rates 2: Relationship of Interest Rates

This is the second in a series of seven papers on interest rates and it covers the relationship between the policy interest rate and the banks’ prime lending rate; the many, but related, interest rates on debt and deposits; the interbank market interest rates; and the relationship of money market 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.

Disentangling India's Investment Slowdown

This paper documents the recent slowdown in investment in India and explores its underlying causes. The sharp investment deceleration has sparked an intense debate about the role of interest rates, as well as business confidence and economic policy uncertainty. Our results suggest that while explaining aggregate investment activity better than nominal interest rates, real interest rates account for only one quarter of the explained investment downturn. In addition, standard macro-financial variables do not fully explain the recent investment slump. Using a new measure of economic policy uncertainty, the results suggest that heightened uncertainty and deteriorating business confidence have played a key role in the recent investment slowdown.

Disentangling India’s Investment Slowdown

This paper documents the recent slowdown in investment in India and explores its underlying causes. The sharp investment deceleration has sparked an intense debate about the role of interest rates, as well as business confidence and economic policy uncertainty. Our results suggest that while explaining aggregate investment activity better than nominal interest rates, real interest rates account for only one quarter of the explained investment downturn. In addition, standard macro-financial variables do not fully explain the recent investment slump. Using a new measure of economic policy uncertainty, the results suggest that heightened uncertainty and deteriorating business confidence have played a key role in the recent investment slowdown.

Interest Rates, Target Markets and Sustainability in Microfinance

This paper presents evidence on the reliability of claims in the literature on microfinance institutions (MFIs) regarding the role of interest rates and institutional design in helping MFIs to realize financial self-sufficiency. It pools data from 426 institutions in 41 developing countries from 2004 to 2008. Contrary to expectations, the results of an ordered-logistic regression strongly support an inverted U-shaped function for the relationship between interest rates and sustainability, irrespective of customer orientation. Additionally, a shift away from the poorest borrowers in the low-end market does not significantly improve the likelihood of being more profitable after controlling for other relevant covariates. MFIs may not, therefore, be forced to drift away from their original goal of serving the underprivileged in pursuit of financial viability.

The role of interest rates in the Brazilian business cycles

This paper offers additional insights on the relationship between interest rates and business cycles in Brazil. First, I document that Brazilian interest rates are very volatile, counter-cyclical and positively correlated with net exports, as observed in other emerging market economies. Next, I present a dynamic stochastic general equilibrium model in which firms face working capital constraints and labor supply is independent of consumption. This parsimonious model, appropriately calibrated to the Brazilian economy, predicts that interest rate shocks can explain about one third of output fluctuations and delivers business cycle regularities consistent with the Brazilian data.

Cyclical wage movements in emerging markets compared to developed economies: The role of interest rates

This paper documents that, at the aggregate level, (i) real wages are positively correlated with output and, on average, lag output by about one quarter in emerging markets, while there are no systematic patterns in developed economies, and (ii) real wage volatility (relative to output volatility) is about twice as high in emerging markets compared with developed economies. We then present a small open economy model with productivity shocks and countercyclical interest rates. The model incorporates a working capital requirement and the Jaimovich and Rebelo (2009) preference that allows for flexible parameterization of the strength of income effects on labor supply. The model can account for the high volatility of wage and consumption relative to output and countercyclical trade balances that characterize emerging-market economies. During economic downturns, rising interest rates in emerging markets induce relatively large income effects on labor supply, so households would not reduce their labor input as much even though wages drop significantly.

Housing Cycle and Interet Rate

The most recent boom-bust episode in the housing market and its unprecedented negative repercussions on the overall economy led to a debate on its possible causes. The common assumption underlying the debate is that interest rates were the main driver of the bubble in house prices. However the empirical literature provides merely inconclusive evidence on the dominant role of interest rates in house price dynamism. Based on a comprehensive review of the existing literature combined with the author's own reasoning and observation, a hypothesis is elicited that not only interest rates but also expectation play major roles in rendering house prices more volatile than otherwise. To check for the validity of it, a different regression strategy from common empirical models is adopted employing the volatile components of house prices as a dependent variable instead of house prices themselves. The empirical results using the U.S. data are consistent with the hypothesis confirming the primacy of interest rates in generating house price fluctuations and the importance of expectation channel transmitting the effects of interest rates.

Real Interest Rates and the Crisis: Where are the Rates Headed?

This paper examines the likely direction of real interest rates in the Euro area and the United States from April 2009 on. It is argued that the crisis that began in 2007 and the ensuing recession changed the descending trend in real interest rates which started a long time ago. If real interest rates were to rise too much, private and public finances, housing markets and stock markets would suffer particularly in the countries where the past credit binge and the crisis response has made debts mount, thus prolonging the current crisis. Economic theory should help shed light on the likely future direction of long-term real interest rates. In the paper, growth models are briefly discussed and shown to offer disparate predictions about the level of real interest rates in a growing economy and little practical guidance. Monetary theories, i.e. theories explicitly focused on the role of interest rates in balancing supply and demand in the single markets of the economy, make reference to some normal or natural level of real interest rate but obviously suffer from the difficulties of estimating such normal or natural levels both in general and particularly in a unusually dynamic and uncertain situation such as the current one. The more pragmatic approach, consisting in the assessment of the relevant single components of the long-term real nominal interest rate over the cycle, points to the risks of a surge in the risk premium as well as in expected short-term real interest rates and thus to a prolongation of the current economic contraction.

Present Value with Random Stopping Times

Discounting an income stream with a random stopping time produces a formula similar to one for a perpetuity, except that a risk premium is added to the discount rate. This results in a valuation equation that is convenient to apply to complex multi-phase income streams. It suggests a framework for empirical research that includes, for example, bankruptcy rates derived from company fundamentals to estimate the expected stopping time of a business, and offers an additional perspective on the role of interest rates in the economy.

Why are Some Currencies Viewed as Benchmarks? The Roles of Interest Rates, Economic Size, and Exchange-Rate Regime

The forward puzzle is traditionally explained as the reflection of a covariance-risk premium, market friction or limits to arbitrage. Recently, Liu and Sercu (2009; henceforth LS), working on intra-ERM rates for the DEM, presented evidence consistent with career-risk considerations (portfolio managers shun assets with danger signals), or with investors otherwise assign fallen-angel status to such assets. In this paper, we test the external validity of this finding: we compare floating rates to band-regime ones, strong base currencies to weak ones, and large economies to small ones. We find that the exchange-rate regime seems to matter the least; but the bench-marking role can come from either a huge economy (the U.S.), a strong currency (Swiss Franc, Dutch Guilder), or good ratings on both counts (Japan and Germany). Consistent with the idea that these are slow-moving reputational effects, the evidence is especially present in the long-run-trend component of the forward premium. In the short-run, filtered part, other factors seem to be at work.

What We Still Don’t Know about Monetary and Fiscal Policy

TWO THOUSAND AND SEVEN may seem an odd moment to question what we know about monetary policy. The past quarter-century has been about as good a run, at least in aggregate dimensions, as one is likely to get--and certainly far superior to what the early Brookings Panel participants, in the 1970s, ever thought likely. The United States has experienced only two business recessions during the last twenty-five years, neither lasting longer than eight months and neither involving a decline in total production as great as 1 1/2 percent. (1) Annual price inflation has converged onto a 1 1/2 to 2 percent norm, with the average increase apart from food and energy (the U.S. central bank's preferred measure) falling exactly in the middle of this range over the past ten years and not a single year as much as 1/4 percentage point either above or below. Neither the severe one-day stock market crash in October 1987, nor the collapse of a good portion of the nation's thrift deposit industry in the late 1980s, nor the protracted stock market decline of 2000-03, nor the quadrupling of world oil prices since 2002 had much, if any, visible impact on either aggregate nonfinancial economic activity or economy-wide inflation. Euroland and most of the world's other advanced economies have enjoyed similarly favorable rides, and even the one outstanding exception--Japan--proves the rule, in that monetary policy there was so plainly wrong-headed. Among academic economists it has become commonplace to hail the tremendous advances in knowledge about the subject, and even to refer to monetary policy, as practiced today, as a science. (2) Fiscal policy today likewise seems on a surer footing of knowledge than in earlier eras. Despite the expense of simultaneously fighting two wars, and despite a tax cut that had put the U.S. government's budget on a path toward deficit even before either war began, the ratio of the government's outstanding interest-bearing debt to national income has fluctuated narrowly within the range of 0.33 to 0.37 since the beginning of the decade. (The government's unfunded liabilities, mostly for Social Security and Medicare, are another matter, but lack of knowledge is not the problem.) The experience of 2001, recalling that of 1981, has even led to some talk of tax cuts in particular as potentially efficacious in spurring recovery from recessions. For the most part, however, fiscal policy has mostly disappeared from discussion at both the popular and the academic levels. Well-earned complacency notwithstanding, some modest reflection suggests that despite the recent gains in knowledge, several questions of some seriousness, about both monetary and fiscal policy, remain to be answered. Some are primarily conceptual, while others spring more directly from operational concerns. But in both of these policy areas, experience suggests that often what starts out as a largely conceptual inquiry leads, in time, to implications with practical import. A Conceptual Question: How Does the Central Bank Make Monetary Policy in the First Place? Most economics textbooks introduce the role of monetary policy by deriving one or more sources of demand for the central bank's liabilities: banks need reserves to satisfy reserve requirements and to settle interbank transactions, the nonbank public needs currency to conduct everyday business, and so on. The next step is to posit, reasonably enough, that the central bank is a monopoly supplier of its own liabilities and therefore can, unless directed otherwise by higher authorities, set that supply at whatever level it chooses. Because both the banks' and the nonbank public's demand for the central bank's liabilities is likely to be interest sensitive, the equilibrium of demand and supply in this market establishes the price at which these liabilities are exchanged for other assets: conceptually, some kind of interest rate. Given the role of interest rates and asset returns more generally in affecting aggregate demand, the economic consequences of monetary policy actions--that is, of changes in the supply of central bank liabilities--follow with however much elaboration seems appropriate. …

The role of interest rates in business cycle fluctuations in emerging countries: The case of Thailand

Emerging economies have enjoyed an exceptionally favourable economic and financing environment throughout 2004 and 2005, supported by solid global growth, low interest rates and suppressed credit spreads. The easy-money policy of the United States of America in recent years has spread worldwide, creating an environment of low interest rates in international markets. If global interest rates were to take a sudden course upward, this would increase the cost of borrowing for emerging economies and lead to less hospitable financing conditions for emerging markets. The purpose of this paper is to measure the effect of shocks on global interest rates on real activity in Thailand. The analysis employs the Global Economy Model developed by the Research Department of the International Monetary Fund and finds that it would be best for Thailand to minimize the effects of rising global interest rates if it were to follow a flexible exchange rate policy.

Excess Monetary Liquidity and Asset Prices

The end of the internet bubble on equity markets and, more recently, the prolonged strength of house prices in most industrial countries, have brought questions about the role of monetary policy back to the fore. While management of the money supply has traditionally been aimed at preventing a resurgence in inflation, in the current context of price stability, the debate has shifted towards the supervision of asset prices. Several factors are commonly cited in connection with the notion of a liquidity effect on asset prices: an extended quantity equation of money including asset transactions; easy credit, which promotes purchasing and impacts prices; the direct role of interest rates in computing the fundamental value of assets; and expectations generated by current monetary policy, especially as reflected in low interest rates. This paper seeks to examine the extent to which these theories are germane and to assess whether, in practice, excess liquidity has had a discernable effect on equity and property prices in the euro area, the USA, the UK and Japan since the beginning of the 1980s. We demonstrate that liquidity, which is by definition an overall instrument of purchasing power, does not actually have an across-the-board effect on asset prices. On the contrary, individual asset price movements are bigger than the overall change in aggregate asset prices. Any econometric analysis of the linkage between asset prices and excess liquidity must factor in the possibility of feedback effects from asset prices to money. For this reason, we estimate VAR and VECM models to look at reciprocal interactions in the four geographical zones covered by the paper. It was impossible to clearly demonstrate the effects of excess liquidity on equity prices. The findings for property prices were more nuanced, especially in the case of the UK. However, even where an effect was detected, its impact was limited. Using the available data on France, we explore the notion of the quantity equation of money extended to assets, and measure its relevance. It turns out that adding property or securities transactions to transactions in goods and services does not stabilise the velocity of money. Thus we do not find support from traditional quantity theory for the idea of a transmission from monetary policy to asset prices. In sum, there is only tenuous evidence that excess liquidity affects asset prices. While speculative bubbles may have formed around equity and property prices, they did not wait for help from monetary policy to take shape. Note, however, that this paper was deliberately conducted within a linear setting. The findings do not therefore refute research demonstrating that beyond a certain threshold, excess liquidity represents a threat to financial stability.

The Role of Interest Rates in Business Cycle Fluctuations in Emerging Market Countries: The Case of Thailand

"Volume 2006 (2006): Issue 110 (May 2006): The Role of Interest Rates in Business Cycle Fluctuations in Emerging Market Countries: The Case of Thailand" published on 01 May 2006 by International Monetary Fund.

The Role of Interest Rates in Business Cycle Fluctuations in Emerging Market Countries: The Case of Thailand

Emerging market countries have enjoyed an exceptionally favorable economic environment throughout 2004, 2005, and early 2006. In particular, accommodative U.S. monetary policy in recent years has helped create an environment of low interest rates in international capital markets. However, if world interest rates were to take a sudden upward course, this would lead to less hospitable financing conditions for emerging market countries. The purpose of this paper is to measure the effects of world interest rate shocks on real activity in Thailand. The analysis incorporates balance sheet related credit market frictions into the IMF’s Global Economy Model (GEM) and finds that Thailand would best minimize the adverse effects of rising world interest rates if it were to follow a flexible exchange rate regime.