Resolving the Interest Rate Premium Puzzle: Capital Inflows and Bank Intermediation in Emerging Economies

Abstract The target of monetary policy is generally set as to create an environment of manageable employment and affordable long-term interest rates. However, priorities of central banks may differ depending on economic and financial circumstances of individual countries. Modern approaches to monetary policy transmission can be grouped under two headings, Money View and Credit View. The money view concentrates on interest rates to explain the effects of monetary policy on aggregate spending by creating an interest rate channel. The credit channel transmission approach focuses on the supply of credits by banks following a monetary policy shift in interest rates. In 2010, the Central Bank of Turkey (CBT) developed an interest rate corridor shaped by one-week and overnight repo lending to the financial banks to absorb excessive volatility caused by short-term capital inflows. Under this framework, the CBT implements its monetary policy in two ways; firstly it can alter the interest rates of weekly repo as well as O/N lending rate. Secondly, it can configure the funding structure it provides to the financial intermediaries. In such a framework, the interest rate transmission mechanism has been operated by two benchmark interest rates, one of which is the weighted average of the cost of funds provided by the CBT and the other is the interest rate in Borsa Istanbul (BIST) money market transactions at an overnight maturity. There is a strong co-movement between the interest rates and they are affected by the movements in the CBT lending rate in both directions. Interest rates applied to deposits and loans by banks are affected by the policy rate (CBT Average Funding Rate) and the market rate (BIST O/N Repo Rate).

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New Evidence on the Forward Premium Puzzle

Journal of Financial and Quantitative Analysis ◽

10.1017/s0022109016000302 ◽

2016 ◽

Vol 51 (3) ◽

pp. 875-897 ◽

Cited By ~ 14

Author(s):

Jacob Boudoukh ◽

Matthew Richardson ◽

Robert F. Whitelaw

Keyword(s):

Exchange Rate ◽

Interest Rate ◽

Purchasing Power Parity ◽

Power Parity ◽

Forward Premium Anomaly ◽

Forward Premium ◽

Premium Puzzle ◽

The Interest Rate ◽

Exchange Rate Changes ◽

Interest Rate Differentials

AbstractThe forward premium anomaly (exchange rate changes are negatively related to interest rate differentials) is one of the most robust puzzles in financial economics. We recast the underlying parity relation in terms of lagged forward interest rate differentials, documenting a reversal of the anomalous sign on the coefficient in the traditional specification. We show that this novel evidence is consistent with recent empirical models of exchange rates that imply exchange rate changes depend on two key variables: the interest rate differential and the magnitude of the deviation of the current exchange rate from that implied by purchasing power parity.

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Measuring monetary policy in emerging economies

Proceedings of the European Union’s Contention in the Reshaping Global Economy ◽

10.14232/eucrge.2020.proc.5 ◽

2020 ◽

Author(s):

Bui Thanh Trung

Keyword(s):

Monetary Policy ◽

Exchange Rate ◽

Interest Rate ◽

Emerging Economies ◽

Condition Index ◽

Var Model ◽

Empirical Results ◽

Implementation Of Monetary Policy ◽

The Interest Rate

Measuring the stance of monetary policy is of importance for the analysis and implementation of monetary policy. The existence of multiple instrument framework as well as the significance of the interest rate and exchange rate channel in emerging economies imply that monetary condition index can play an important role in evaluating whether monetary policy is restrictive or expansive in these economies. In this paper, we use the VAR model to evaluate the role of monetary condition index as an overall measure of monetary policy in emerging economies. The weight of components of monetary condition index is derived from the inflation equation in the VAR estimation. The empirical results suggest that a contraction in monetary policy causes a reduction in inflation. The finding implies that monetary condition index is a useful indicator that can predict the stance of monetary policy and predict the trend of inflation in emerging economies.

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A NOTE ON OPENNESS AND INFLATION TARGETING: IMPLICATIONS FOR THE UNPLEASANT FISCAL ARITHMETIC

Macroeconomic Dynamics ◽

10.1017/s1365100512000752 ◽

2013 ◽

Vol 18 (5) ◽

pp. 1187-1207 ◽

Cited By ~ 6

Author(s):

Helder Ferreira de Mendonça ◽

Igor da Silva Veiga

Keyword(s):

Interest Rate ◽

Emerging Economies ◽

Public Debt ◽

Capital Mobility ◽

Inflation Targeting ◽

Financial Openness ◽

Capital Account Liberalization ◽

High Interest Rate ◽

The Interest Rate ◽

Primary Surplus

Emerging economies that have adopted inflation targeting and that combine low credibility, high public debt, and a high interest rate suffer from a typical problem. Increases in the interest rate to reduce departures of inflation from the target imply that a higher primary surplus is required for stabilizing public debt/GDP ratio. This tricky situation is known as “unpleasant fiscal arithmetic” (UFA). This article develops a theoretical model showing how increased financial openness and capital account liberalization can mitigate UFA. Furthermore, empirical evidence from the Brazilian case through OLS, GMM, and GMM system methods is offered. The findings show that increases in capital mobility and financial openness work as a commitment technology, which contributes to the success of the inflation targeting and thus reduces the risk of UFA.

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What Does Pakistan Have to Join the Inflation Targeters’ Club—a Royal Flush or a Seven-Deuce Offsuit?

THE LAHORE JOURNAL OF ECONOMICS ◽

10.35536/lje.2012.v17.i2.a2 ◽

2012 ◽

Vol 17 (2) ◽

pp. 35-62

Author(s):

Syed Kumail Abbas Rizvi ◽

Bushra Naqvi ◽

Sayyid Salman Rizavi

Keyword(s):

Interest Rate ◽

Emerging Economies ◽

Significant Relationship ◽

Inflation Targeting ◽

Granger Causality Test ◽

Causality Test ◽

The Core ◽

Core Requirements ◽

The Interest Rate

The economic and institutional structure required to successfully adopt and implement an inflation targeting framework (ITF) is often lacking in emerging economies. This paper evaluates these structures both qualitatively and quantitatively for Pakistan’s economy. Although our comprehensive assessment finds that many of the core requirements remain unrealized, the literature and real-time experience argue that an ITF remains possible for emerging economies even in the absence of these conditions. We investigate whether—were the State Bank of Pakistan to adopt an ITF—there exists a stable and significant relationship between the policy rate (monetary tool) and inflation measure (objective). It is important to analyze this bivariate relationship, given the key role of the interest rate in mitigating deviations between actual and target inflation when working within an ITF. To illustrate this relationship, we use Granger Causality test, but our estimates fail to find any significant link between the interest rate and inflation. On the basis of our overall findings, we suggest that Pakistan, in the absence of most of the fundamental requirements of an ITF, is perhaps not yet ready for it.

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The Role of Different Channels in Transmitting Monetary Policy into Output and Price in Vietnam

Journal of Economics and Development ◽

10.33301/2015.17.01.02 ◽

2015 ◽

pp. 20-40

Author(s):

Vinh Nguyen Thi Thuy

Keyword(s):

Monetary Policy ◽

Exchange Rate ◽

Interest Rate ◽

Money Supply ◽

Monetary Transmission ◽

Impulse Response Functions ◽

Short Run ◽

The Exchange Rate ◽

The Interest Rate ◽

Interest Rate Channel

The paper investigates the mechanism of monetary transmission in Vietnam through different channels - namely the interest rate channel, the exchange rate channel, the asset channel and the credit channel for the period January 1995 - October 2009. This study applies VAR analysis to evaluate the monetary transmission mechanisms to output and price level. To compare the relative importance of different channels for transmitting monetary policy, the paper estimates the impulse response functions and variance decompositions of variables. The empirical results show that the changes in money supply have a significant impact on output rather than price in the short run. The impacts of money supply on price and output are stronger through the exchange rate and credit channels, but however, are weaker through the interest rate channel. The impacts of monetary policy on output and inflation may be erroneous through the equity price channel because of the lack of an established and well-functioning stock market.

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DETERMINAN INFLASI DI INDONESIA PERIODE 1980-2015

Jurnal Ekonomi dan Bisnis ◽

10.24123/jeb.v21i1.1631 ◽

2016 ◽

Vol 21 (1) ◽

pp. 1-7

Author(s):

Risna Risna

Keyword(s):

Interest Rate ◽

Interest Rates ◽

Money Supply ◽

Government Spending ◽

Positive Impact ◽

Secondary Data ◽

Quantitative Approach ◽

State Spending ◽

Factors Affecting ◽

The Interest Rate

This study aims to determine the effect of government spending, the money supply, the interest rate of Bank Indonesia against inflation.This study uses secondary data. Secondary data were obtained directly from the Central Bureau of Statistics and Bank Indonesia. It can be said that there are factors affecting inflationas government spending, money supply, and interest rates BI. The reseach uses a quantitative approach to methods of e-views in the data. The results of analysis of three variables show that state spending significantand positive impact on inflationin Indonesia, the money supply significantand negative to inflationin Indonesia, BI rate a significantand positive impact on inflation in Indonesia

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Insurance Companies and the Interest Rate

Financial Analysts Journal ◽

10.2469/faj.v9.n4.15 ◽

1953 ◽

Vol 9 (4) ◽

pp. 15-17

Author(s):

Shelby Cullom Davis

Keyword(s):

Interest Rate ◽

Insurance Companies ◽

The Interest Rate

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Analyzing the financial and economic momentum as a result of changes in the interest rate

National Interests Priorities and Security ◽

10.24891/ni.16.9.1656 ◽

2020 ◽

Vol 16 (9) ◽

pp. 1656-1673

Author(s):

V.V. Smirnov

Keyword(s):

Interest Rate ◽

Natural Gas ◽

Central Bank ◽

Crude Oil ◽

Oil Prices ◽

Global Capitalism ◽

Positive Effects ◽

Russian Economy ◽

Oil And Natural Gas ◽

The Interest Rate

Subject. The article discusses financial and economic momenta. Objectives. I determine financial and economic momenta as the interest rate changes in Russia. Methods. The study is based on a systems approach and the method of statistical analysis. Results. The Russian economy was found to strongly depend on prices for crude oil and natural gas, thus throwing Russia to the outskirts of the global capitalism, though keeping the status of an energy superpower, which ensures a sustainable growth in the global economy by increasing the external consumption and decreasing the domestic one. The devaluation of the national currency, a drop in tax revenue, etc. result from the decreased interest rate. They all require to increase M2 and the devalued retail loan in RUB, thus rising the GDP deflator. As for positive effects, the Central Bank operates sustainably, replenishes gold reserves and keeps the trade balance (positive balance), thus strengthening its resilience during a global drop in crude oil prices and the COVID-19 pandemic. The positive effects were discovered to result from a decreased in the interest rate, rather than keeping it low all the time. Conclusions and Relevance. As the interest rate may be, the financial and economic momentum in Russia depends on the volatility of the price for crude oil and natural gas. Lowering the interest rate and devaluing the national currency, the Central Bank preserves the resource structure of the Russian economy, strengthens its positions within the global capitalism and keeps its status of an energy superpower, thus reinforcing its resilience against a global drop in oil prices.

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