Short-term and long-term interest rates in a monetary model of a small open economy

Abstract We study a real small open economy with two key ingredients (1) partial segmentation of home and foreign bond markets and (2) a pecuniary externality that makes the real exchange rate excessively volatile in response to capital flows. Partial segmentation implies that, by intervening in the bond markets, the central bank can affect the exchange rate and the spread between home- and foreign-bond yields. Such interventions allow the central bank to address the pecuniary externality, but they are also costly, as foreigners make carry trade profits. We analytically characterize the optimal intervention policy that solves this trade-off: (1) the optimal policy leans against the wind, stabilizing the exchange rate; (2) it involves smooth spreads but allows exchange rates to jump; (3) it partly relies on “forward guidance,” with non-zero interventions even after the shock has subsided; (4) it requires credibility, in that central banks do not intervene without commitment. Finally, we shed light on the global consequences of widespread interventions, using a multi-country extension of our model. We find that, left to themselves, countries over-accumulate reserves, reducing welfare and leading to inefficiently low world interest rates.

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CANDIDE et la monnaie

L Actualité économique ◽

10.7202/800659ar ◽

2009 ◽

Vol 52 (1) ◽

pp. 75-103

Author(s):

Jean-Pierre Aubry ◽

Pierre Duguay

Keyword(s):

Interest Rate ◽

Interest Rates ◽

Term Structure ◽

Structural Equations ◽

Reduced Form ◽

Real Sector ◽

Short Term ◽

The Real ◽

Structure Equations

Abstract In this paper we deal with the financial sector of CANDIDE 1.1. We are concerned with the determination of the short-term interest rate, the term structure equations, and the channels through which monetary policy influences the real sector. The short-term rate is determined by a straightforward application of Keynesian liquidity preference theory. A serious problem arises from the directly estimated reduced form equation, which implies that the demand for high powered money, but not the demand for actual deposits, is a stable function of income and interest rates. The structural equations imply the opposite. In the term structure equations, allowance is made for the smaller variance of the long-term rates, but insufficient explanation is given for their sharper upward trend. This leads to an overstatement of the significance of the U.S. long-term rate that must perform the explanatory role. Moreover a strong structural hierarchy, by which the long Canada rate wags the industrial rate, is imposed without prior testing. In CANDIDE two channels of monetary influence are recognized: the costs of capital and the availability of credit. They affect the business fixed investment and housing sectors. The potential of the personal consumption sector is not recognized, the wealth and real balance effects are bypassed, the credit availability proxy is incorrect, the interest rate used in the real sector is nominal rather than real, and the specification of the housing sector is dubious.

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Macroeconomic Synchronization Between G3 Countries

German Economic Review ◽

10.1111/1468-0475.00055 ◽

2002 ◽

Vol 3 (2) ◽

pp. 137-153 ◽

Cited By ~ 3

Author(s):

Amado Peirό

Keyword(s):

Business Cycle ◽

Interest Rates ◽

Short Term ◽

The Us ◽

Production Prices ◽

Over Time

AbstractThis paper studies the existence of a world business cycle by examining quarterly and annual comovements in production, prices and interest rates in the three main world economies: Germany, Japan and the US. In accordance with earlier studies, contemporaneous relationships clearly dominate short-term dynamics. The evidence indicates the existence of strong comovements in prices and long-term interest rates, and, to a lesser degree, in GDP and short-term interest rates. They are, however, rather unstable over time.

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Journal of the History of Economic Thought Preprints - Limits to Arbitrage and Interest Rates: A Debate Between Keynes, Hawtrey and Hicks

10.31235/osf.io/7f2yv ◽

2018 ◽

Author(s):

Lucy BRILLANT

Keyword(s):

Business Cycle ◽

Central Bank ◽

Interest Rates ◽

Economic Thought ◽

History Of Economic Thought ◽

Short Term ◽

Limits To Arbitrage ◽

History Of ◽

The Business Cycle

This paper deals with a debate between Hawtrey, Hicks and Keynes concerning the capacity of the central bank to influence the short-term and the long-term rates of interest. Both Hawtrey and Keynes considered the central bank’s ability to influence short-term rates of interest. However, they do not put the same emphasis on the study of the long-term rates of interest. According to Keynes, long-term rates are influenced by future expected short-term rates (1930, 1936), whereas for Hawtrey (1932, 1937, 1938), long-term rates are more dependent on the business cycle. Short-term rates do not have much effect on long-term rates according to Hawtrey. In 1939, Hicks enters the controversy, giving credit to both Hawtrey’s and Keynes’s theories, and also introducing limits to the operations of arbitrage. He thus presented a nuanced view.

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BUDGET DEFICITS AND INTEREST RATES IN A SMALL OPEN ECONOMY – ANOTHER LOOK AT THE EVIDENCE: REPLY *

International Economic Journal ◽

10.1080/10168730200080011 ◽

2002 ◽

Vol 16 (2) ◽

pp. 31-36 ◽

Cited By ~ 2

Author(s):

GEORGE A. VAMVOUKAS

Keyword(s):

Interest Rates ◽

Open Economy ◽

Small Open Economy ◽

Budget Deficits

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How loan interest rate liberalization affects firms’ loan maturity structure

China Finance Review International ◽

10.1108/cfri-06-2013-0078 ◽

2014 ◽

Vol 4 (2) ◽

pp. 153-167 ◽

Cited By ~ 3

Author(s):

Jianfang Zhou ◽

Jingjing Wang ◽

Jianping Ding

Keyword(s):

Interest Rate ◽

Interest Rates ◽

Manufacturing Companies ◽

Short Term ◽

Data Set ◽

Content Type ◽

Interest Rate Liberalization ◽

Upper Limit ◽

Maturity Structure

Purpose – After loan interest rate upper limit deregulation in October 2004, the financing environment in China changed dramatically, and the banks were eligible for risk compensation. The purpose of this paper is to focus on the influence of the loan interest rate liberalization on firms’ loan maturity structure. Design/methodology/approach – Based on Rajan's (1992) model, the authors constructed a trade-off model of how the banks choose long-term and short-term loans scales, and further analyzed banks’ loan term decisions under the loan interest rate upper limit deregulation or collateral cases. Then the authors used an unbalanced panel data set of 586 Chinese listed manufacturing companies and 9,376 observations during the period 1996-2011 to testify the theoretical conclusion. Furthermore, the authors studied the effect on firms with different characteristics of ownership or scale. Findings – The results show that the loan interest rate liberalization significantly decreases the private companies’ reliance on short-term loans and increases sensitivity to interest rates of state-owned companies’ long-term loans. But the results also show that the companies’ ownership still plays a key role on the long-term loans availability. When monetary policy tightened, small companies still have to borrow short-term loans for long-term purposes. As the bank industry is still dominated by state-owned banks and the deposit interest rate has upper limits, the effect of the loan interest rate liberalization on easing long-term credit constraints is limited. Originality/value – From a new perspective, the content and findings of this paper contribute to the study of the effect of the interest rate liberalization on China economy.

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