Stable Interest Rates Research Articles

Shifts in US Federal Reserve Goals and Tactics for Monetary Policy: A Role for Penitence?

This paper considers some of the large changes in the Federal Reserve's approach to monetary policy. It shows that, in some important cases, critics who were successful in arguing that past Fed approaches were responsible for mistakes that caused harm succeeded in making the Fed averse to these approaches. This can explain why the Fed stopped basing monetary policy on the quality of new bank loans, why it stopped being willing to cause recessions to deal with inflation, and why it was temporarily unwilling to maintain stable interest rates in the period 1979–1982. It can also contribute to explaining why monetary policy was tight during the Great Depression. The paper shows that the evolution of policy was much more gradual and flexible after the Volcker disinflation, when the Fed was not generally deemed to have made an error.

An Equilibrium Asset Pricing Model with Labor Market Search

Frictions in the labor market are important for understanding the equity premium in the financial market. We embed the Diamond-Mortensen-Pissarides search framework into a dynamic stochastic general equilibrium model with recursive preferences. The model produces realistic equity premium and stock market volatility, as well as a low and stable interest rate. The equity premium is countercyclical, and forecastable with labor market tightness, a pattern we confirm in the data. Intriguingly, three key ingredients (small profits, large job flows, and matching frictions) in the model combine to give rise endogenously to rare disasters a la Rietz (1988) and Barro (2006).

The Monetary Transmission Mechanism, Non-residential Fixed Investment and Housing

We specify a vector autoregression (VAR) model for the U.S. for 1980–2008 to investigate the statistical causal relationships between private non-residential fixed investment, the effective Federal funds rate, personal consumption expenditures, nonfinancial corporate profits, and the nonfinancial corporate credit market debt to test the validity of macroeconomic relationships in a macro model. The VAR utilizes the Toda-Yamamote procedure to test for Granger causality. Our preliminary results show that the transmission mechanism does not work as expected; we find that fixed investment depends on the level of demand in the economy and profits but not on the interest rate. This casts doubt on the usual assumptions about how the monetary transmission mechanism is expected to work. The second part of the paper investigates the effects of the change in the monetary regime towards low and stable interest rates, a policy pursued by the U.S. Fed since the beginning of the 1990s. We find that the new monetary policy regime has the following effects: (1) our VAR model does not support the hypothesis that low interest rates lead to higher fixed nonresidential investment; (2) low interest rates led to a search for higher yields through increasing risk, and (3) they led to an increase in the demand for securitized assets, especially mortgage-backed securities, which eventually resulted in a housing bubble. The overall results therefore raise doubts about the effectiveness of low interest rates as a policy regime designed as a component of a counter-cyclical policy.

The Analysis of Yields of Regional Financial Institutions against the Benchmark Based on Sharpe Ratios

Owing to persistent deflation and low and stable long-term interest rates, the average loan-to-deposit ratio of Japanese financial institutions has declined, while the average JGB-holding ratio of them has increased gradually over the past decade. To analyze the attitude of regional financial institutions in Japan as risk-takers, firstly, we estimated the benchmark portfolio consists of loans and JGBs which maximize its Sharpe ratio after the collapse of the bubble economy. Secondly, we calculate the logarithmic values of the variances of actual yields on the interest earning assets of them from FY 2001 to FY 2010. Thirdly, we conduct an empirical analysis to know what attributes of them have much effect on the logarithmic values of variances. It means that we analyze what regional financial institutions tried to increase their loans at their own discretion.

Revealing the preferences of the US Federal Reserve

AbstractWe use Bayesian methods to estimate changes in US post‐war monetary policy in the Smets and Wouters model. We perform the estimations by allowing for a break in monetary policy at the time of Volcker's appointment as chairman. This enables us to capture changes in the monetary policy regime introduced by Volcker during the Volcker–Greenspan period. We find support for the assumption that monetary policy in the Volcker–Greenspan period performed optimally under commitment. Our estimation strategy allows us to estimate the preferences of the US Federal Reserve in the Volcker–Greenspan period, where the main objective of policy appears to be inflation, followed by interest rate stabilization, output growth and interest rate smoothing. We find that the Great Moderation of output growth is explained by a combination of two factors: the decrease in the volatility of the structural shocks and the improved monetary policy conduct. Inflation Stabilization, however, is mainly due to the change in monetary policy that took place at the beginning of Volcker's mandate. Copyright © 2010 John Wiley & Sons, Ltd.

Optimal Monetary Policy, the Zero Bound and the Term Structure of Interest Rates

Optimal Monetary Policy, the Zero Bound and the Term Structure of Interest Rates

Preferences of the central bank of Brazil under the inflation targeting regime: commitment vs. discretion

This work aims to estimate the preferences of the Central Bank of Brazil during the inflation targeting regime, using a standard new keynesian model with forward-looking expectations, as proposed by Givens (2010). The presence of rational expectations in the model makes a distinction between two modes of optimization, commitment and discretion, and thus allows us to evaluate which of these specifications is favored by the data. Using quarterly data for the period from 2000-1 to 2010-4, the obtained results allow us to affirm that the data favor a discretionary policy. Estimates of the loss function show that the monetary authority gives great weight to inflation stabilization, followed by interest rate smoothing and stabilization of the output gap.

Coping With The Risk Of Interest Rate Fluctuations: The Case Of Kuwait Banks

This study analyzed immunization behavior of a sample of eight Kuwait banks during the 1994 through 2000 period. The financial market in Kuwait experienced relative stability of interest rates during the analysis period. The sample banks seemed to adjust their portfolio of assets and liabilities by equating Macaulay duration of assets and Macaulay duration of liabilities. We could not reject the null hypothesis that there is no difference between average Macaulay duration of assets and that of liabilities. Our findings indicate that banks in Kuwait are able to match the durations of their assets and liabilities.

Term Structure and Interest Rate Stabilization Policies: New Evidence

Previous studies impute the failure of the expectations theory, using 6 and 3-month Treasury bill spread, to the Fed.s commitment to stabilize interest rates.We get that from Greenspan tenure on, that spread predicts future changes in the short rate in the United States. This success is ascribed to improved interest rates predictability achieved by the Fed which, as well as enhancing the management of market expectations, has reduced uncertainty acquiring credibility form the market (now asking for lower term premia).

Does Mr. Market Suffer from Bipolar Disorder?

Benjamin Graham, the father of value investing, argued that the stock market (which he coined “Mr. Market”) suffers from a mood disorder known as bipolar disorder (formerly called manic depression). Warren Buffet and John Maynard Keynes have also endorsed the idea that market psychology has an influential role to play in the stock market. According to Graham, the mood of Mr. Market is unstable and frequently oscillates between mania and depression. To engage a good understanding of mood disorders, the Diagnostic and Statistical Manual of Mental Disorders (DSM), published by the American Psychiatric Association, is consulted. Various versions of mood disorder are discussed. Based on observation, it is plausible that the stock market indeed suffers from bipolar disorder. The market mood model (MMM) is developed to model the dynamics of market mood. It is divided into six market phases, and each phase has its own set of market characteristics. There is a critical point for each phase and, once breached, the market moves on to the next phase. The application of the MMM utilizes three market bubbles as illustration: 1990 Japanese bubble, 2000 Internet bubble and 2007 subprime mortgage crisis. The final section examines the option of adopting a stable official interest rate policy to stabilize asset prices.

Bank margin determination: a comparison between Islamic and conventional banks in Indonesia

PurposeThe purpose of this paper is to examine the relationship between Islamic bank margin (BM) and its determinants. It also compares the BM behavior of Islamic and conventional banks in the Indonesian dual banking system.Design/methodology/approachThe paper employs a time series approach under the dealership framework of Ho and Saunders. The autoregressive distributed lag model is used to inspect cointegration between BM and its determinants for the period of January 1996 to February 2006 of five sample banks (two Islamic banks and three conventional banks).FindingsThe result confirms that there exists a long‐running relationship between the Islamic BM and its determinants. In particular, as interest rate volatility increases, Islamic BM responds negatively while that of conventional banks responds positively. The findings differ from most of the other studies as they found a positive relationship between BM and interest rate volatility. This paper also shows that the margin behavior changes as the basis of bank operations changes from conventional to Islamic principles.Research limitations/implicationsThe paper uses a relatively small sample of three (out of 150) conventional banks as a comparison to two sample Islamic banks. However, as they come from the same peer with the Islamic banks, it is believed that the finding is valid. Islamic banks in Indonesia are not remote from the interest rate volatility in their presence under a dual banking system. It is the displaced commercial risk that threatens Islamic banking profitability in a changing market interest rate situation.Practical implicationsUnder a dual banking system, the stability of interest rates and the financial system is of great importance for the policy maker in developing the Islamic banking industry in Indonesia. As long as the BM is still a major source of income to the Islamic banks, it is necessary for Islamic banks to have prudent risk management to mitigate the negative effect of displaced commercial risk and maintain its profitability. Implementation of profit equalization reserves concept is a possible measure for Islamic banks to shield their operation.Originality/valueThis paper is believed to be the first study on Islamic BM behavior in Indonesia. It is expected to provide useful information for policy makers and Islamic bank management to develop a sound and profitable Islamic banking industry in Indonesia.

Bank Margin Determination: A Comparison Between Islamic and Conventional Banks in Indonesia

Purpose – The purpose of this paper is to examine the relationship between Islamic bank margin (BM) and its determinants. It also compares the BM behavior of Islamic and conventional banks in the Indonesian dual banking system. Design/methodology/approach – The paper employs a time series approach under the dealership framework of Ho and Saunders. The autoregressive distributed lag model is used to inspect cointegration between BM and its determinants for the period of January 1996 to February 2006 of five sample banks (two Islamic banks and three conventional banks). Findings – The result confirms that there exists a long-running relationship between the Islamic BM and its determinants. In particular, as interest rate volatility increases, Islamic BM responds negatively while that of conventional banks responds positively. The findings differ from most of the other studies as they found a positive relationship between BM and interest rate volatility. This paper also shows that the margin behavior changes as the basis of bank operations changes from conventional to Islamic principles. Research limitations/implications – The paper uses a relatively small sample of three (out of 150) conventional banks as a comparison to two sample Islamic banks. However, as they come from the same peer with the Islamic banks, it is believed that the finding is valid. Islamic banks in Indonesia are not remote from the interest rate volatility in their presence under a dual banking system. It is the displaced commercial risk that threatens Islamic banking profitability in a changing market interest rate situation. Practical implications – Under a dual banking system, the stability of interest rates and the financial system is of great importance for the policy maker in developing the Islamic banking industry in Indonesia. As long as the BM is still a major source of income to the Islamic banks, it is necessary for Islamic banks to have prudent risk management to mitigate the negative effect of displaced commercial risk and maintain its profitability. Implementation of profit equalization reserves concept is a possible measure for Islamic banks to shield their operation. Originality/value – This paper is believed to be the first study on Islamic BM behavior in Indonesia. It is expected to provide useful information for policy makers and Islamic bank management to develop a sound and profitable Islamic banking industry in Indonesia.

The process of nominal and real convergence under the conditions of monetary integration

The creation of the Economic and Monetary Union is the next stage of monetary integration. Due to differentiation between Member States of the European Union, expenses and profits of participation in Eurosystem are not spread similarly. The first part of this paper reviews the fulfillment of nominal Maastricht criteria (stability of public finances, prices, exchange rate and interest rates). The second part presents the state of real convergence between countries either belonging to or aspiring to European Economic and Monetary Union (flexibility of prices and salaries, mobility of means of production, integration of financial markets, openness of economy, diversification of production and consumption and similarity of economic disorders). Analyses are based on available statistical data and scientific research.

ASYMMETRIC PREFERENCES FOR INTEREST RATE VARIABILITY AND NON‐LINEAR MONETARY POLICY INERTIA

ABSTRACTIntroducing in a central bank loss function asymmetric preferences for interest rate stabilization together with a (symmetric) smoothing goal could lead to asymmetric interest rate smoothing. An empirical analysis supports this theoretical result and finds for the disinflation (Volcker) period a more cautious adjustment of interest rates downwards than upwards, and for the ‘price stability’ (Greenspan) period a more inertial behaviour in the opposite direction.

Cycles, Trends and Financial Crisis: Understanding the Impacts of Monetary Policies

Low interest rate environment encourages borrowing. During inevitable downturns in business cycles, heavy borrowing makes it more vulnerable to financial crisis. Low interest rate environments also favor high fixed cost investments, which have low variable costs and hence, have more significant scale economy than low fixed cost investments. In a large and growing economy, high fixed cost investments earn higher rates of returns than low fixed cost investments. During last several centuries, fueled by the abundant cheap nonrenewable resources, the global economy has been expanding more or less uninterrupted. In such a growth economy, low interest rate policy, which favors high fixed cost investment, has been mostly beneficial to overall economic activities, although it also induces financial crisis from time to time. However, many signs indicate that the upward trend of economic output will end soon. In the new environment, higher and stable interest rates will narrow the gap between cost of borrowing and expected rate of inflation, which will reduce the incentive for speculation. A high interest rate environment will also enhance the competitiveness of small firms as low fixed cost entities. Small firms are more labor intensive and less resource intensive, which is especially helpful in a world with increasing resource scarcity and high unemployment rates.

Měnová politika a predikce variability úrokových sazeb na peněžním trhu

This study presents an analysis of the sources of variability of interest rates in the money market in the context of Czech National Bank's (CNB) monetary policy. The factors in question are changes in the structural characteristics of economies in transition, changing perception of inflation risks, the inconsistency of central bank's monetary decisions and central bank's weakened credibility and uncertainty about the efficient transmission of monetary measures. The empirical analysis documents non-stationary variability of ultra short-term PRIBOR interest rates and stability of longer maturity PRIBOR interest rates. These results reflect the role of CNB in bank system liquidity management, the uncertainty about the timing of CNB's monetary policy at the changing speed of the appreciation of the crown, tendencies of overestimation of expected inflation and changing structural characteristics.

ARE UK SHARE PRICES TOO HIGH? FUNDAMENTAL VALUE OR NEW ERA

Since the mid-1990s the dividend yield reached and largely remained at a historically low level, even accounting for the stock market correction in the early 2000s. This appears to suggest that prices are overvalued. However, alternative valuation models based upon comparing bond and equity yields suggest that, if anything, prices are undervalued. This paper seeks to provide answers to this seeming paradox. Preliminary results suggest non-stationarity of the dividend yield and bond yield‐equity yield differential, although the yield ratio is possibly stationary, casting doubt on mean reversion. Evidence from structural breakpoint testing suggests that all measures have been subjected to several mean level shifts throughout the sample period, and notably within the last decade, such that each series now fluctuates around a mean level lower than that experienced previously. Thus, the lower dividend yield and lower bond‐equity ratio do not necessarily imply equity mispricing but that concepts of pre-existing normal levels no longer apply. In explaining why higher equity prices are supported, we note that the last decade has seen a period of historically low and stable inflation and interest rates. Further, there is a strong positive relationship between inflation and the dividend yield. This more stable economic environment has led to more accurate valuation of stocks and lower required rates of return, thus supporting higher prices.

Central bank communication and output stabilization

Some central banks have a reputation for being secretive. A justification for this behaviour that we find in the literature is that being transparent about operations and beliefs hinders the central bank in achieving the best outcome. In other words, a central bank needs flexibility and therefore cannot be fully transparent. Using a forward-looking New-Keynesian model, we find exactly the opposite. A central bank that is conservative improves output stabilization by being transparent about the procedures it uses to assess the economy and, especially, about the forecast errors it makes. Under certain conditions transparency by a conservative central bank also improves interest rate stabilization. We also find that higher transparency makes it optimal for the central bank to be more conservative as the benefits from higher transparency in terms of output stabilization are greater the more conservative the central bank is.

Optimal interest rate stabilization in a basic sticky-price model

This paper studies optimal monetary policy with the nominal interest rate as the single policy instrument. Firms set prices in a staggered way without indexation and real money balances contribute separately to households’ utility. The optimal deterministic steady state under commitment is the Friedman rule—even if the importance assigned to the utility of money is small relative to consumption and leisure. We approximate the model around the optimal steady state as the long-run policy target. Optimal monetary policy is characterized by stabilization of the nominal interest rate instead of inflation stabilization as the predominant principle.

The Value of Interest Rate Stabilization Policies When Agents Are Learning

We examine the expectational stability (E‐stability) of rational expectations equilibrium in the “New Keynesian” model where monetary policy is optimally derived and interest rate stabilization is added to the central bank's traditional objectives of inflation and output stabilization. We consider both the case where the central bank lacks a commitment technology and the case of full commitment. We show that for both cases, optimal policy rules yield rational expectations equilibria that are E‐stable for a wide range of empirically plausible parameter values. These findings stand in contrast to Evans and Honkapohja's findings for optimal monetary policy rules in environments where interest rate stabilization is not a central bank objective.