Monetary policy and long-term US interest rates

This doctoral dissertation is composed of three articles focused on analyzing international spillovers of monetary policy. The first article investigates the spillover effects of monetary policy among OECD countries. First, it appears that, more recently, monetary policy decisions diverge from those indicated by the Taylor Rule. Thus, the article aims to verify if there is a spillover effect in the interest rate decisions of central banks. We apply the methodological framework of spatial econometrics to circumvent the endogeneity problem. Considering the SAR model and a W weight matrix that shows the trade relationship between countries, it is found that countries take into account the international interest rate, besides considering the differential between inflation and its target and the output gap. In the second article, based on classical DSGE models, we analyze the spillover effects of monetary policy by including the foreign interest rate in the domestic monetary agent\\'s decision process. The model shows that the relationship between domestic and foreign interest rates depends on the parameters used, particularly the intertemporal elasticity of consumption and the country\\'s degree of openness. Considering reasonable values for these parameters, we found a positive relationship between the foreign and domestic rates. Furthermore, in the model estimated for Brazil considering the Taylor Rule with Consumer Price Index (CPI), it was found that a negative shock in the US interest rate generates a drop in the Brazilian rate, stimulating activity and consumption. Therefore, domestic prices rise. However, the CPI declines with the appreciation of the exchange rate, leading to a slow return of the interest rate to the steady state. The third paper seeks to measure the welfare costs generated by the spillover effects of monetary policy. Starting from a non-linear model, we apply the methodology proposed by Schmitt-Grohe and Uribe (2004b) and found that regardless of the importance of the foreign interest rate in domestic decisions, the optimal monetary policy is consistent with an aggressive response of interest rates to inflation and a more mild reaction to the output gap. Comparing different rules, we found some evidence that the central bank incurs social welfare loss when considering the international interest rate. Finally, it is worth noting that the cost depends on the Taylor Rule\\'s coefficients and, to a greater extent, on the degree of openness of the economy.

In economic literature there are two different views on the effects of inflation expectations on interest rates, called liquidity effect and Fisher effect. According to the liquidity effect, an increase in inflationist expectations results as a decrease in both nominal and real interest rates. According to the Fisher effect, there is a one-to-one correspondence between a change in inflation expectations and nominal interest rate in the long-run which implies that monetary policy is irrelavant on the real interest rate. Therefore a test of the long run relationship between nominal interest rate and inflation rate is important on understanding the effects of the monetary policy on interest rates. In this study the presence of the Fisher effect is investigated for Turkey under the assumption of adaptive expectations.

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We investigate and compare the determinants of US and Australian interest rate swap spreads and the linkages between these markets. The slope of the risk‐free term structure is the most significant determinant and its importance is greater for longer terms to maturity. Interest rate levels and, in Australia, the default premium also have some impact. The influences of interest rate volatility, the liquidity premium and (in the USA) the default premium are small or negligible. We hypothesise, and our evidence confirms, that the US swap market significantly affects the Australian swap market but not vice‐versa.

Japan's interest rates have been compressed toward zero because of pressure coming through the foreign exchanges. Twenty years of current‐account surpluses have led to a huge buildup of claims – mainly dollars – on foreigners. Because of ongoing fluctuations in the yen/dollar exchange rate, Japanese financial institutions will only willingly hold these dollar claims if the nominal yield on them is substantially higher than on yen assets. In the 1990s to 2002 as US interest rates have come down, portfolio equilibrium has been sustained only when nominal interest rates on yen assets have been forced toward zero. One consequence is the now infamous liquidity trap for Japanese monetary policy. A second consequence is the erosion of the normal profit margins of Japan's commercial banks, leading to a slump in new bank credit and an inability to grow out of the overhang of old bad loans.

The response of nominal interest rates to price increases has been intensively studied since the onset of substantial inflation and historically high interest rates in the late 1960s. Early empirical investigations (Yohe and Karnosky (1969), Gibson (1972), and Pyle (1972)) tested the Fisher hypothesis that nominal rates react one-for-one to changes in the expected inflation rate. Paralleling results in the wage-price literature, these studies often found that nominal rates appeared to adjust too little to imply neutrality with respect to expected inflation. Theoretical work by Mundell (1963) and Tobin (1965) that incorporated wealth effects, by Sargent (1972) that considered an extended macromodel, and by Darby (1975) and Feldstein (1976) that allowed for income tax effects, however, suggested that additional variables, like measures of fiscal and monetary policy, may be relevant and that nominal rates may change by either more or less than unity in response to a one unit change in expected inflation. Two puzzling features of the response of nominal rates to expected inflation remain. First, even when other factors are included, estimates of that response are unstable for the postwar period (see Cargill and Meyer (1977)). Second, empirical studies to date have failed to produce any statistically discernible impact of expected inflation on interest rates during the 1950s (see Cargill and Meyer (1974) and Cargill (1976)). Similarly striking is the sizeable residual autocorrelation exhibited by nearly all estimates that include the 1950s. These symptoms of model misspecification imply that an important factor may have been omitted from previous models. A reduced form model of nominal interest rates that allows for an additional impact, that of factor supply shocks, is advanced in section II. The empirical tests in section III show that, once this variable is included, a significant relation between interest rates and expected inflation emerges for the 1950s. We also show that our specification is stable over the entire post-Accord period. Section IV concludes.

Nominal interest rates may remain substantially below the averages of the last half century, because central banks' inflation objectives lie below the average level of inflation, and estimates of the real interest rate that are likely to prevail over the long run fall notably short of the average real interest rate experienced during this period. Persistently low nominal interest rates may lead to more frequent and costly episodes at the effective lower bound (ELB) on nominal interest rates. We revisit the frequency and potential costs of such episodes in a world of low interest rates, using both a dynamic stochastic general equilibrium (DSGE) model and the Federal Reserve's large-scale econometric model, the FRB/US model. Four main conclusions emerge. First, monetary policy strategies based on traditional, simple policy rules lead to poor economic performance when the equilibrium interest rate is low, with economic activity and inflation more volatile and systematically falling short of desirable levels. Moreover, the frequency and length of ELB episodes under such policy approaches are estimated to be significantly higher than in previous studies. Second, a risk adjustment to a simple rule—whereby monetary policymakers are more accommodative, on average, than prescribed by the rule—ensures that inflation averages its 2 percent objective, and requires that policymakers systematically seek inflation near 3 percent when the ELB is not binding. Third, commitment strategies, whereby monetary accommodation is not removed until either inflation or economic activity overshoots its long-run objective, are very effective in both the DSGE and FRB/US models. And fourth, our simulation results suggest that the adverse effects on economic and price stability associated with the ELB may be substantial at inflation targets near 2 percent if the equilibrium real interest rate is low and monetary policy follows a traditional approach. Whether such adverse effects could justify a higher inflation target depends upon the degree to which monetary policy strategies that differ substantially from such traditional approaches are feasible, and an assessment of a broader array of the inflation target's effects on economic welfare.

The Central Bank held power to carry out a monetary policy through the setting of monetary targets such as the money supply or interest rates with the main objective of maintaining inflation at the level determined by the government. At the operational level, this monetary objective depends on the use of instruments, including open market operations in the foreign exchange market, the setting of the discount rate, the setting of minimum reserve requirements and regulating credit or financing. We analyzed the causality of Bank Indonesia (BI Rate) and US interest rates (Federal Fund Rate). This study used secondary data, especially data from Bank Indonesia and The Federal Reserve. This data was the ones from the monthly time series from January 2006 to May 2016. This study used Granger causality test to determine the causality of BI Rate and Federal Fund Rate. Granger Causality test results indicated that there was no causality between the BI Rate and the Federal Fund Rate. We found that the movement of interest rates was not only caused by the external side, but also by the internal side. The case in Indonesia showed that the movement of interest rates was mainly due to an increase in gross domestic product, low participation in the Global Value Chain and the adoption of the expansionary monetary policy. JEL Classification : E43, E52, E58 DOI: https://doi.org/10.26905/jkdp.v22i3.1972

Recent events have highlighted the potential importance of nonlinear efiects of flscal variables (notably debt and deflcits) on interest rates: While in times when government solvency is not a concern the standard crowding-out efiects are of moderate magnitude, in times when default risk becomes an issue the interest rate efiects can become very large. This paper provides new evidence on the magnitude of these efiects. For the case when default risk is not a concern, it uses an arbitrage-free term structure model to estimate the dynamic efiects of flscal policy shocks on interest rates along the entire maturity spectrum. For the case when default risk becomes a concern (thereby violating a central assumption of the term structure model), I present evidence based on EMU government bond spread regressions on time-varying efiects of national flscal policies on spreads as well as the time-varying sensitivity of yield spreads to international risk aversion as a function of the state of flscal policy. JEL classiflcation: E6, H6.

This paper presents new evidence on how asset prices respond to new information about the money stock. It shows that the information content of money stock announcements and the response of asset prices to new information in the announcements vary with changes in the monetary policy regime, the Federal Reserve operating procedures, and the reserve accounting rules. While previous studies have examined how asset prices respond to the money stock announcements under the interest-rate targeting procedure and the nonborrowed reserve procedure, we have included new evidence from the borrowed reserve targeting procedure under both lagged and contemporaneous reserve accounting rules. Looking at how both forward exchange rates and other asset prices respond to the announcements, we distinguish between periods when the asset-price response reflected a change in the real interest rate and those when it reflected a change in the inflation premium. Finally, we show that the new contemporaneous reserve accounting rules have greatly reduced the information content of the money stock announcements.

Jumps, Interest Rates, and Monetary Policy

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Did Quantitative Easing Affect Interest Rates Outside the US? New Evidence Based on Interest Rate Differentials

This paper re-examines international transmissions of monetary policy shocks from advanced economies to emerging market economies. In terms of methodologies, it combines three novel features. First, it separates co-movement in monetary policies due to common shocks from spillovers of monetary policies from advanced to peripheral economies. Second, it uses surprises in growth and inflation and the Taylor rule to gauge desired changes in a country's interest rate if it is to focus exclusively on growth, inflation, and real exchange rate stability. Third, it proposes a specification that can work with the quantitative easing episodes when no changes in US interest rate are observed. In terms of empirical findings, we differ from the existing literature and document patterns of "2.5-lemma" or something between a trilemma and a dilemma: without capital controls, a flexible exchange rate regime offers some monetary policy autonomy when the center country tightens its monetary policy, yet it fails to do so when the center country lowers its interest rate. Capital controls help to insulate periphery countries from monetary policy shocks from the center country even when the latter lowers its interest rate.

Significance Having fallen against the resurgent dollar this year, the zloty has lately been strengthening, since the US Federal Reserve surprised financial markets by striking a more dovish stance than expected on both the timing and pace of the anticipated tightening in monetary policy. While the zloty and Polish stocks had suffered because of fears of a rise in US interest rates, local bonds have been underpinned by the ECB's quantitative easing (QE) programme. The effects of QE and a brisker economic recovery may temporarily offset the risk of an inconclusive result in the parliamentary election in October. Impacts Investors have yet to price in the risk of a hung parliament in Poland following October's election. The vote could lead to the formation of a weak and unstable coalition government. The risk of an unstable coalition is particularly high, given the strong likelihood that PO's share of the vote will decline sharply.