Interest Rate Target Research Articles

Expectations and the neutrality of interest rates

Our central banks set interest rates, and do not even pretend to control money supplies. How do interest rates affect inflation? We finally have a complete economic theory of inflation under interest rate targets and unconstrained liquidity. Its long-run properties mirror those of monetary theory: Inflation can be stable and determinate under interest rate targets, including a peg, analogous to a k-percent rule.Uncomfortably, stability means that higher interest rates eventually raise inflation, just as higher money growth eventually raises inflation. Sticky prices generate some short-run non-neutrality: Higher nominal interest rates can raise real rates and lower output. A model in which higher nominal interest rates temporarily lower inflation, without a change in fiscal policy, is a harder task. I exhibit one such model, but it paints a more limited picture than standard beliefs. Generically, without a change in fiscal policy, monetary policy can only move inflation from one time to another.The last decade has provided a near-ideal set of natural experiments to distinguish the principal theories of inflation. Inflation did not show spirals or indeterminacies at the long zero bound. The large monetary-fiscal expansion of the covid era produced a temporary spurt of inflation. The same money unleashed in quantitative easing had no such effect.

The Impact of Unexpected FOMC Actions on Corporate Earnings Expectations

This paper fills a gap in the literature by examining the impact of unexpected Federal Open Market Committee (FOMC) actions on the markets expectations of U.S. corporate earnings by examining the sell-side analysts' quarterly earnings forecasts from 1989 to 2022. This paper reveals a significant negative correlation between analysts' earnings forecasts and unexpected changes in the target interest rate. This correlation weakened after the Federal Reserves implementation of Forward Guidance as a monetary tool in 2004, which appears to enhance the market's ability to predict target rate adjustments. In addition, this paper shows that with a given amount of unexpected target rate changes, value firms display greater earnings forecast revisions from analysts than growth firms. Debt levels or profitability factors cannot fully explain this phenomenon. The findings of this paper contribute to the knowledge of how FOMC actions exert influence on equity valuations and the transmission mechanisms of monetary policies.

The interest rate pass-through by loan size: Evidence for Mexico, 2011-2019

This paper measures the impact of changes in the central bank's reference rate on bank lending rates at both the aggregate level and by loan size. Our data come from the payroll and personal loan markets in Mexico for the period comprising 2011 to 2019. We use an autoregressive model with distributed lags, which allows for the possibility of asymmetric effects. The results show, among other findings, that the pass-through is small; it is not necessarily positive; asymmetric behaviour cannot be ruled out; and, its value depends on the loan size. These results imply that the effectiveness of monetary policy is weakened, in addition to the fact that the reaction of banks to changes in the target interest rate may have distributional implications. The originality of the paper lies in the grouping of interest rates by loan size and the use of a methodology that allows us to assess the existence of asymmetries. Its main shortcoming is the lack of data regarding the characteristics of the borrowers.

HOW EFFECTIVE AND EFFICIENT ARE THE NEW “PROGRESSIVE” PUBLIC POLICIES?

In this work we deal with the recent (1995-2024) Federal Reserve operated monetary policies, which were two unprecedented and distinct monetary policy regimes. They were, the inflation stabilization era (1995-2008) and the zero-interest rate era (December 15, 2008-December 15, 2015) and again (March 15, 2020-March 15, 2022), plus the current corrective period (March 16, 2022-present). These different monetary policy regimes provided various outcomes for interest rates, financial markets, inflation, cost of living, employment, international trade, and real economic growth. Then, a new “progressive” fiscal policy was imposed in 2021. Some of the important, but not so beneficial results are that monetary policy appears to be able to affect long-term real interest rates, risk, the prices of the financial assets (bubbles), inflation, and very little the real economic growth. The Fed’s interest rate target was set during these nine years at 0% to 0.25%. It has created a low level of long-term interest rates and the negative real rate of interest (cost of capital), due to double digit inflation and a negatively sloped yield curve. The evidence suggests that these public policies are not very effective; they have created a new and continued bubble in the financial market, perpetuated inflation, enormous deficits and debts, a redistribution of wealth from risk-averse savers to banks and risk-taker speculators, and a huge social cost (bail-in and bail-out cost), an endless vicious cycle. This unfair and anti-social monetary policy has increased the risk (RP) to the risk-averse depositors by making the real rate of interest negative and the cost to taxpayers with the IOR and the IONRRP. The effects on growth and employment of both public policies (monetary and fiscal) were gradual, small, and questionable, due to exaggerated liquidity, outsourcing, unfair trade policies, the suspicious COVID-19 pandemic, liberalism, the obsession with the “environment”, the “war” against fossil energy, the enormous inflow of illegal immigrants, the new wrong ideologies, the control of human beings, the wars in Ukraine, Palestine and Lebanon, the division among the political parties and the unethical campaigns for the presidential elections, and other restrictions and “innovations”, which increased uncertainty, the cost of production and generated enormous deficits and debts.

Monetary policy transmission mechanism in Indonesia period 2002: Q1 – 2020: Q4: interest rate and asset price channel

This study aims to determine and analyze the effect of the monetary policy transmission mechanism on the interest rate channel and asset prices in Indonesia in achieving the ultimate goal of price stability throughout the period 2002:Q1 – 2020:Q4. This study uses secondary data related to policy interest rate variables, operational target interest rates, information variables, and final target variables for each channel of the monetary policy transmission mechanism. The analytical tool used in this research is the Vector Error Correction Model (VECM) which is processed using statistical software Eviews 10. The results of the analysis on the monetary policy transmission mechanism model of the interest rate channel indicate that in the short term, investment lending variables have a negative and significant effect on The CPI, meanwhile, the investment credit interest rate variable has a negative and significant effect. The results of the long-term analysis of the monetary policy transmission mechanism model of the interest rate channel show that the interest rate for investment credit, consumption credit, and the BI7DRR interest rate have a positive and significant effect on the CPI, while the variables for consumption credit interest rates, investment credit distribution, and real GDP negative and significant effect on the CPI. The results of the VECM analysis for the monetary policy transmission mechanism model for asset price channels confirm that the positive Error Correction Term (ECT) coefficient indicates that there is no adjustment mechanism towards long-term equilibrium. The results of the classical assumption test for the monetary policy transmission mechanism model of asset price channels also confirm deviations in the assumptions of normality and heteroscedasticity. Therefore, the economic interpretation of the VECM estimation on the monetary policy transmission mechanism model of the asset price channel cannot be carried out and requires the use of other analytical tools to produce a valid model .

Evidence on monetary transmission and the role of imperfect information: Interest rate versus inflation target shocks

We present new empirical evidence on monetary transmission by incorporating two types of shocks – a standard temporary interest rate shock and a persistent inflation target shock. In an estimated DSGE model under imperfect information, where agents may be unable to distinguish these shocks, we find delayed Neo-Fisherian behavior in response to the persistent shock: interest rate and inflation increase, but with a lag. In an empirical VAR model that accounts for such uncertainty in identifying assumptions, we similarly find evidence for positive co-movement of interest rates and inflation in the short aftermath of the persistent shock, however, not on impact. This suggests that, when pursuing a higher inflation target, the central bank needs to engineer an expansionary monetary policy stance by lowering its real interest rate path and also initially lowering the nominal rate to stimulate inflation and inflation expectations.

Anaysis of Interest Rate Spread, Financial Development and Foreign Capital Inflow Nexus in Nigeria

ABSTRACT: The world has gone through various economic crises in the past century, and their effects have had varying implications on the economies of countries all over the world. In a bid to help stabilise economies all over the world, various measures have been put in place. Some of these measures include regulations and policies by the Bretton Woods institutions (World Bank and International Monetary Fund) and their agencies. The idea behind these measures is to ensure sustainable growth and development among member states and other countries of the world. Some of these policies include the privatization and liberalization policies of the Bretton Woods institutions as well as other policies bordering on such economic and social benefits for people all over the world. The Nigerian economy in our contemporary time can be described as passing through a rather 'volatile' phase with respect to interest rate, financial development and foreign capital inflow. Thus, this study investigated the impact of interest rate spread and financial development on foreign capital inflow in Nigeria. Several studies have been carried out using different methodologies, such as; co-integration equation, multivariate vector auto regressive (VAR) model and vector error correction technique. Each methodology used was in line with the objective of the research in question. However, to achieve its objective, this paper adopted the Classical Linear Regression Model. The results of the study showed that financial development has a positive impact on foreign capital inflow, while interest rate spread on the other hand, was also found to have a positive impact on foreign capital inflow. Other control variables such as market capitalization and treasury bills rate were also found to positively affect foreign capital inflow, while the all share index had a negative impact on foreign capital inflow. Some economists have opined that the Nigerian economy is currently going through a phase of recession. In order for large scale investments to be made within the country, there is a need for foreign participants to be attracted to the Nigerian economy and pull their resources, both financial and non-financial into the country (but, not without regulation). However, for these investors to have confidence to make investments in the Nigerian economy, there has to be a high degree of economic stability in the country. This can be supported by enacting and implementing policies that can enhance the quality of interest rates spread and financial development within the country. The policy implication here involves enhancing financial development through sound policies and adopting competitive interest rates, could increase the rate of foreign inflow into the economy. In view of this, it is also recommended that government policies should target interest rate competitiveness, financial and economic development as well as sustainability.

The Monetary Policy Preferences of Left- and Right-Wing Populism

The paper uses a Taylor-rule model for central banks to examine the economic outcome of modern populism. Annual data of major OECD countries from 2001 to 2019 is applied to examine the overall level of populism in the regime, the left/right divide of the regime and the populist political force, the independence of the central bank from the political regime to model the target interest rate. The results verify the impact of populism on monetary policy and the invalidity of the traditional partisan approach, and distinguish the different effect of left- and right-wing populism. A populist regime favors low interest rate than a non-populist regime, and a leftist populist regime prefers expansionary monetary policies than rightist populist regime. Such a divide in monetary policy preference can be used as a classification criterion for classification of populist political forces, with The Five Star Movement in Italy as an example.

Public debt sustainability in a target zone model with heterogeneous agents

Relying on the assumption of perfect information and agent homogeneity, previous interest rate target zone models could well account for situations of government debt stability (‘honeymoon’) or instability (‘divorce’). In those models, however, the transition from one state to another could only occur with a discrete change in the interest rate and thus could not account for the gradual transition from ‘honeymoon’ to ‘divorce’ that occurred in the months leading up to the euro area crisis of 2011–12. The assumption of heterogeneous agents made in this interest rate target zone model, on the other hand, allows that graduality to be represented. Heterogeneous agents are assumed to be characterized by normally distributed beliefs about the maximum sustainable level of the debt-to-GDP ratio. When public debt increases due to an assumed process of stochastic shocks, therefore, the percentage of agents sharing the belief that they have entered a region of instability also increases, thus leading to the gradual transition from ‘honeymoon’ to ‘divorce,’ observed in the euro area crisis of 2011–2012.

The Practical Application and Marginal Expansion of Keynesian Model

Recently, there have been a lot of discussion about how variable change will affect output, real wages, and the nominal values of stock in certain assumptions. This paper describes improved new Keynesian model in closed economy for showing the adjustment of different component. Firstly, it will discuss the condition when an increase in tax by using mathematical derivation and examine the change when a rise in nominal wage through the use of macroeconomic analysis, then it will analyze the process when changing the target interest rate. Lastly, it will provide some evaluations of these several conditions. The results of the studies indicate that while an increase in tax, the real wages will rise, output will decline and the nominal money stock will do the same. Besides, the analysis has revealed that when a growth in nominal wages will result in a boost in price level and nominal money stock, and production remains constant. Additionally, when the target interest rate is raised, output will fall, real wages will rise as a result of a declining price level and a fixed nominal wage, and the nominal money stock will drop. All these preliminary results throw light on real life scenarios of central banks and countries.

The interest rate pass-through by loan size: Evidence for Mexico, 2011-2019

This paper measures the impact of changes in the central bank's reference rate on bank lending rates at both the aggregate level and by loan size. Our data come from the payroll and personal loan markets in Mexico for the period comprising 2011 to 2019. We use an autoregressive model with distributed lags, which allows for the possibility of asymmetric effects. The results show, among other findings, that the pass-through is small; it is not necessarily positive; asymmetric behaviour cannot be ruled out; and, its value depends on the loan size. These results imply that the effectiveness of monetary policy is weakened, in addition to the fact that the reaction of banks to changes in the target interest rate may have distributional implications. The originality of the paper lies in the grouping of interest rates by loan size and the use of a methodology that allows us to assess the existence of asymmetries. Its main shortcoming is the lack of data regarding the characteristics of the borrowers.

The Questionable Effectiveness and Efficiency of the New Public Policies

In this paper we deal with the recent (1995-2023) Federal Reserve operated monetary policies, which were two unprecedented and distinct monetary policy regimes. The inflation stabilization era (1995-2008) and the zero-interest rate era (December 15, 2008-December 15, 2015) and again (March 15, 2020-March 15, 2022).These different monetary policy regimes provided various outcomes for interest rates, financial markets, inflation, cost of living, employment, international trade, and real economic growth. Then, a new fiscal policy was imposed in 2020. Some of the important results are that monetary policy appears to be able to affect long-term real interest rates, risk, the prices of the financial assets (bubbles), and very little the real economic growth. The Fed’s interest rate target was set during these nine years at 0% to 0.25%.It has created a low level of long-term interest rates and the negative real rate of interest (cost of capital). The evidence suggests that these public policies are not very effective; they have created a new bubble in the financial market, future inflation, and a redistribution of wealth from riskaverse savers to banks and risk-taker speculators. This monetary policy has increased the risk (RP) to the risk-averse depositors by making the real rate of interest negative. The effects on growth and employment of both public policies (monetary and fiscal) were gradual, small, and questionable, due to exaggerated liquidity, outsourcing, COVID-19, liberalism, high cost of production, the “environment”, enormous debts, and unfair trade policies.

The Fiscal Transmission Mechanism of Inflation

The link between money creation and inflation has been theoretically demonstrated, but different inflation responses to Federal Reserve activity after the Great Recession and COVID recession showed the incomplete nature of the theory. We model a “fiscal transmission mechanism” whereby Federal Reserve purchases of Treasury securities lead to inflation as new dollars flow through fiscal deficits into the economy. In our model, other Federal Reserve activity generally lacks inflationary effects. Using a nonstructural vector autoregression approach, we test for the presence of this mechanism and offer near perfect predictions of the 2022 inflation rate using a time series extending back half a century. We explain the fiscal transmission mechanism and the reasons why other Federal Reserve activity lacks the same effects, and we propose an emphasis on controlling the money supply by limiting Federal Reserve purchases of Treasury securities as a better way to control inflation than setting an interest rate target.

Does M1 Money Supply Affect US Exports?

M1 money is defined by the Federal Reserve as money in circulation as well as money in demand deposit accounts such as a checking account. The Fed, as it is commonly referred to as, uses this figure to target interest rates in the economy. This is done to either stimulate the economy to provide growth, or to slow economic growth to curb inflation. By manipulating interest rates in the economy, however, the Fed can also encourage or deter foreign investment, as investors always seek the highest return. If many investors wish to invest in the United States this strengthens the U.S. dollar, effectively raising the price of exported goods. Due to the inverse relationship between price and quantity demanded, higher prices should lead to lower quantities of American goods demanded and vice versa. Depending on the elasticity of this demand, an increase in M1 money supply could either increase or decrease U.S. exports. In this study, regression analysis which of these is in fact the case.

Fiscal Histories

The fiscal theory states that inflation adjusts so that the real value of government debt equals the present value of real primary surpluses. Monetary policy remains important. The central bank can set an interest rate target, which determines the path of expected inflation, while news about the present value of surpluses drives unexpected inflation. I use fiscal theory to interpret historical episodes, including the rise and fall of inflation in the 1970s and 1980s, the long quiet zero bound of the 2010s, and the reemergence of inflation in 2021, as well as to analyze the gold standard, currency pegs, the ends of hyperinflations, currency crashes, and the success of inflation targets. Going forward, fiscal theory warns that inflation will have to be tamed by coordinated monetary and fiscal policy.

Implementing the commitment solution via discretionary policy-making

AbstractThis paper demonstrates that, in a large class of linear-quadratic models with rational expectations, losses due to time-inconsistency problems can be avoided, as the commitment solution can be implemented by a policy-maker who acts under discretion. We focus on two approaches. First, we show that a non-Markovian, reputational equilibrium that implements the commitment solution always exists. Second, we show how delegation to a policy-maker with an additional objective for the policy instrument can be used to implement the commitment solution via a standard discretionary Markov equilibrium. Implementation is facilitated by the fact that the commitment outcome can be attained irrespective of the weight that the policy-maker assigns to the additional target. Using the standard new Keynesian model as an example, we study the dynamics of the economy under optimal additional output targets as well as optimal interest-rate targets for central banks.

The Taylor Rule in Egypt: Is it Optimal? Is there Equilibrium Determinacy?

We investigate Egypt's Taylor rule (interest rate targeting) between 1976 and 2019 by including the main economic variables in its reaction function. Using the Taylor principle, we investigate Egypt’s monetary policy optimality. To this end, we conduct the generalized method of moments (GMM) estimation procedure with different Taylor rule specifications to deal with potential endogeneity among variables. Our GMM estimates reveal that the partial adjustment coefficient is of considerable magnitude, indicating the explanatory power of policy inertia on many total variations in the current values of the nominal interest rate in Egypt. Furthermore, the inflation gap coefficient violates the Taylor principle, making the policy procyclical and inflation "spiral" and inducing divergence from the long-run equilibrium. Therefore, Egypt's Taylor rule, and thus monetary policy, reflects the indeterminacy of equilibrium and is a passive and destabilizing policy. Besides, the output gap coefficient was unexpectedly found to be insignificant.

The Effect of Monetary Policy on Price Stability and Gross Domestic Product in Ghana

This study examined the effects of monetary policy on price stability and gross domestic product (GDP) in Ghana using a predictive data analytical model adapted from Friedman's (1982) models. Monetary policy adopted a two-target framework based on both the policy interest rate target and the bank credit aggregate target. Hypotheses tests were conducted using Vector Auto-Regressions (VARs) and Multiple Regression Analyses using secondary data. The VAR tests produced a statistically weak relationship between both price stability and real GDP and the two-target monetary policy framework. The results from the multiple regression analyses, however, indicated statistically significant relationships between the price stability and interest rate targets and those of real GDP and bank credit aggregate targets, thus confirming the model’s predictive capability. The study therefore recommends that for the achievement of price stability and the expansion of real GDP simultaneously, a two-target framework of monetary policy be implemented in Ghana.

Monetary policy application and stock market reaction during Covid-19 Pandemic: Evidence from Turkey

We investigate whether the pandemic announcement and three monetary policies changed after that (reducing target interest rate) have an impact on the return, liquidity, and volatility in the Turkish stock market. We find that there is a negative reaction to the pandemic announcement and the announcement of the first decline in interest rates, but we discover a positive reaction to the second and third reduction in interest rates in terms of stock return and liquidity. Moreover, the stock return and liquidity of firms that are listed on the BIST-100 index and have associated derivatives are affected less by the pandemic. Results also suggest that the smallest, illiquid, volatile, and highly searched companies on Google are affected more by the pandemic announcement and the first decline in the interest rate.

The stabilizing effect of the zero lower bound: A perspective of interest rate target zones

This study first sets up a simple stochastic macro model embodying rational expectations, and then develops a graphical presentation to examine whether the zero lower bound (ZLB) tends to stabilize or destabilize relevant macroeconomic variables from the viewpoint of interest rate target zones. Within the standard IS−LM&AD−AS framework, this paper finds that in response to an increase in supply or demand shocks, the ZLB leads to a decline in the public’s inflation expectations. We also find that, when the economy experiences an aggregate supply shock, the ZLB will raise the variability of both prices and nominal interest rates, but reduce the variability of output. However, when the economy experiences a money demand shock, the ZLB tends to raise the variability of nominal interest rates, but reduce the variability of both prices and output.