Interest Rate Channel

10 Key excerpts on "Interest Rate Channel"

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  eBook - ePub

  Negative Interest Rates and Financial Stability

  Lessons in Systemic Risk

  • Karol Rogowicz, Małgorzata Iwanicz-Drozdowska(Authors)
  • 2022(Publication Date)
  • Routledge

    (Publisher)

  Brózda-Wilamek, 2018 ).

  Two effects can be considered as falling under the Interest Rate Channel: the interest rate directly affecting investment through the changes in cost of capital (to which Figure 2.7 referred) and the intertemporal substitution channel (the change of preferences in intertemporal choice). How the interest channel works is due to nominal price rigidity,23 which is reflected in a proportional change of real rates once the central bank changes the nominal rate (Beyer et al., 2017 ). The expectations channel, on the other hand, is a certain enhancement of the Interest Rate Channel as it shows that the central bank may affect the real economy by shaping the expectations of business entities. The expectations chiefly concern two categories: the average level of short-term interest rates in the future and the future inflation rate (e.g., Łyziak, 2011 ), whereas the effect the central banks has on them depends on the credibility of the monetary policy pursued.

  Figure 2.7 Simplified scheme of monetary policy mechanism in negative interest rates environment

  Source: Own elaboration.

  The third channel regards monetary policy effect on the exchange rate. In accordance with uncovered interest rate parity, and in spite of the initial appreciation of the domestic currency after monetary policy tightening, if the domestic interest rate is higher than its foreign counterpart, depreciation will ensue in medium term so as to align the rates of return (Chmielewski et al., 2018 ). Moreover, two effects can be distinguished within the exchange rate channel (Mishkin, 2001 ): the relative price effect bearing on net exports and its opposite, balance sheet effect which bears on the balance sheet structure of business entities (scale of this influence is determined by the balance sheet net currency position; Demchuk et al., 2011

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  Developing Sustainable Balance of Payments in Small Countries

  Lessons from Macroeconomic Deadlock in Jamaica

  • Andre Haughton(Author)
  • 2017(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  The speed of adjustment mechanism is examined using the error correc- tion model. At first sight our data shows almost a parallel movement between the lending and deposit rates in Jamaica, especially over the last four years. It is expected that the level of pass-through has updated since Haughton and Iglesias (2013). 9.2 INTEREST RATE PASS-THROUGH A clear understanding of the interest rate pass-through process and the speed of adjustment of the monetary transmission mechanism is necessary to determine how changes in monetary policy affect the economy of 9.2 INTEREST RATE PASS-THROUGH 151 developing countries. In most of these countries the financial systems function less efficiently due to deficiencies in the market organization for equities and securities as well as by capital controls and ceilings on bank lending and borrowing rates. Most empirical papers thus far discuss the Interest Rate Channel and the credit channel. The Interest Rate Channel consists of two assets: money and other assets. A fall in the level of reserves will cause reduction in deposits. Likewise, as capital market borrowing becomes more expensive investment spending will decrease. This pre- sumed inefficiency of the money channel resulted in the creation of the credit channel. The credit channel is comprised of a broad channel and the bank lending channel. The broad lending channel assumes that information asymmetries and moral hazard restrict the ability of firms to obtain exter- nal finance. In recent years, commercial banks’ lending channels have been said to be more relevant to developing countries based on the premise that investments are mostly financed by banks where changes in monetary policy affect the supply of loans directly. According to Ramey (1993), there are two key conditions that must be satisfied before a lending channel can be made operational.

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  Uncertainty and Challenges in Contemporary Economic Behaviour

  • Ercan Özen, Simon Grima, Ercan Ozen(Authors)
  • 2020(Publication Date)
  • Emerald Publishing Limited

    (Publisher)

  Chapter 5 Econometric Analysis for the Period Between 2003 and 2018 as Regards the Functioning of Interest Channel of Monetary Transmission Mechanism in Turkey Berna Kaçar and Huriye Gonca Diler Abstract Introduction: Monetary policy resolutions issued by central banks play effective role in economy when accompanied with interest variable. In Keynesian approach to finance, interest is treated as the main determinant underlying financial policy resolutions. Thus interest is a pivotal factor in monetary transmission mechanism. Tight monetary policy practices, essentially decreasing money supply, eventually lead to a slump in investments, total demand and national income due to the increase in real interest rates. Objective: The aim of this study is to determine what type of effects do monetary policy practitioner in Turkey have on macroeconomic variables via the interest channel of monetary transmission mechanism. Methodology: Based on this objective, variables that could help in unveiling CBT overnight interest rates, direct fixed capital investment (GSSO), real gross domestic product (RGDP), industry production index (SUE) and domestic producer price index (YUFE) variables and that could explain monetary functions of transmission mechanism’s interest channel were selected. For the variables constituting the research topic, collected data belong the period of 2003Q1–2018Q3. Findings: In the study relation between the variables has been analyzed under two parts via harnessing Toda–Yamamoto casualty test. In the first part, results of Toda–Yamamoto causality test from RGDP, GSSO and interest rate (FO) variables have been presented. The results manifest that interest channel directly affects direct fixed capital investment and RGDP. Interest channel was found to be effective on these variables of the analysis. In the second part, Toda–Yamamoto causality test was harnessed for SUE, YUFE and FO variables

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  How Monetary Policy Works

  • Lavan Mahadeva, Peter J N Sinclair(Authors)
  • 2004(Publication Date)
  • Routledge

    (Publisher)

  In conclusion, a tightening of monetary policy should cut asset values and, at least temporarily, reduce investment. These effects should be stronger, and more easily discerned, in real-estate prices and construction activity than in equity prices and non-construction investment. Yet monetary factors form only one of several influences affecting all these variables. Furthermore, since interest rates are normally changed for a reason—to try to offset the inflation effects of some shock—it is hard in practice to disentangle the consequences of interest rate changes from those of the shock that precipitated them. This applies to investment no less than to consumption.

  2.7 Conclusion

  This chapter has examined how and why policy interest rates changed, and then turned to key initial aspects of the transmission mechanism for policy rates—their impact on other interest rates, other asset prices, and the major components of aggregate demand, consumption and investment. The next stages of the transmission mechanism concern how a change in the level of aggregate demand translates into changes in output and prices, and labour markets. These questions, together with the special features of the open economy, statistical features of inflation, and evidence on interest rates and disinflation, are examined in Chapter 3 .

  Appendix

  This Appendix begins with the short run econometric results tracing the links from central banks’ policy rates to retail deposit rates (Table 2.3 ) and retail lending rates (Table 2.4 ). This is followed by regression statistics for changes in real consumption growth against changes in nominal rates, levels of real rates, and other regressors (Table 2.5 ).

  Table 2.3

  Dynamic regressions of short-run adjustment from central bank rates through to deposit rates.

  Notes Regression of the change in deposit rates on a constant, ECM-1, change in the central bank rate (non-lagged and one lag), the change in deposit rates (one lag and two lags).

  Monthly data. Sample period is 1980. 1 to 2000. 12 unless adjusted to match that of quarterly estimate; long run equilibrium correction mechanism (ECM) series constructed using co-efficient from quarterly data estimate. ***, **, *: significance of estimate at 1%, 5%, and 10% respectively; t-statistics in brackets; data source: International Financial Statistics.

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  Regional Monetary Policy

  • Carlos Javier Rodriguez Fuentes(Author)
  • 2005(Publication Date)
  • Routledge

    (Publisher)

  2 A dichotomized view of the economic process The transmission channels of monetary policy

  2.1 Introduction

  There is a large amount of literature which deals with the transmission mechanism of monetary policy, i.e. the way monetary policy exerts its effect on economic activity.1 The basic assumption which underlies this ‘transmission mechanism view’ is that a real and monetary side of the economy can be clearly distinguished, where the monetary transmission is the way through which both sides interact with each other. Furthermore, real forces of the economy are seen as determining not only the value of real variables such as the level of income and employment but also real interest rates. Interest rates are hence considered to be a ‘real phenomenon’ since they are determined by, on the one hand, the real forces of productivity (investment decision), and thrift (savings decision) on the other. Interest rates are thus determined in the goods market by the interaction between savings and investment schedules, being its role to equalize both decisions. Within this framework financial variables are seen as factors which may or may not help the economic system to reach its ‘real equilibrium’ by means of easing or speeding up the exchange of goods and services already produced. Nevertheless, monetary variables do not play any role in determining the real outcome itself, since the only role which is left for money to play is a ‘negative’ one, in the sense that, at best, it is considered to be responsible for determining the general level of prices (inflation) in the long run or business cycles in the short run. Within this schedule money matters, but for its potential power to disrupt the real economy.

  The aim of this chapter is to review the discrepancies between different schools of economic thought with regard to the specification of the transmission mechanism. It will be shown that, for some economists, this mechanism takes on the form of a direct and simple effect which runs from changes in money supply to expenditure. On the contrary, other economists believe that the way through which monetary variables affect economy is not so clear, more complicated and indirect than monetarists sustain. This group is usually known as Keynesians.

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  Financial Institutions, Markets, and Money

  • David S. Kidwell, David W. Blackwell, David A. Whidbee, Richard W. Sias(Authors)
  • 2016(Publication Date)
  • Wiley

    (Publisher)

  This chapter explains the role of interest rates in the economy and provides a basic explanation of the fundamental determi- nants of interest rates. The chapter serves as a foundation for Chapters 5 and 6, which also deal with interest rates. ■ vectorfusionart/Shutterstock Even though we understand the factors that cause interest rates to change, only people who have a crystal ball can predict interest movements well enough to make consistent profits. The gutters of Wall Street are littered with failed interest rate prediction models. 4.1 WHAT ARE INTEREST RATES? For thousands of years, people have been lending goods to other people, and on occasion, they have asked for some compensation for this service. This compensation is called rent— the price of borrowing another person’s property. Similarly, money is often loaned, or rented, for its purchasing power. The rental price of money is called the interest rate and is usually expressed as an annual percentage of the amount of money borrowed. Thus, an interest rate is the price of borrowing money for the use of its purchasing power. To a person borrowing money, interest is the penalty paid for consuming income before it is earned. To a lender, interest is the reward for postponing current consumption until the maturity of the loan. During the life of a loan contract, borrowers typically make periodic interest payments to the lender. On maturity of the loan, the borrower repays the same amount of money borrowed (the principal) to the lender. Like other prices, interest rates serve an allocative function in our economy. They allocate funds between surplus spending units (SSUs) and deficit spending units (DSUs) and among financial markets. For SSUs, the higher the rate of interest, the greater the reward for postponing current consumption and the greater the amount of saving in the economy.

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  The Monetary Transmission Process

  Recent Developments and Lessons for Europe

  • D. Bundesbank(Author)
  • 2001(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  Let me brie¯y go through some examples. Goods markets One important characteristic of the goods markets which affects the transmis- sion channels of monetary policy is the degree of openness. While the Euro Area as a whole will be a relatively closed economy ± with a ratio of exports to Concluding Remarks 285 GDP of about 15 per cent, it is only marginally more open than the United States or Japan ± there is a fair degree of dispersion within the Euro Area (see Table C1.1). For example, Belgium is about three times as open to the non- Euro Area as Spain. As a consequence, while the exchange rate channel may be relatively less important for the Euro Area as a whole, the strength of its impact on output and in¯ation may be quite different across countries. Similarly, the overall interest elasticity of aggregate demand will depend on the importance of interest rate sensitive sectors in the economy. For example, Carlino and DeFina (1998) ®nd that, within the United States, regions with a higher weight of construction and manufacturing in the economy are more strongly affected by the Federal Reserve System's monetary policy. If similar considerations are true within the Euro Area, then one could expect that, for example, Germany and Spain should experience a stronger Interest Rate Channel than the Netherlands or Belgium. Another sector which is highly responsive to the level of the interest rate is the housing sector. Maclennan, Muellbauer and Stephens (1998) have expressed concern about the implications of cross-country differences in the tax and legal framework of housing markets for the transmission mechanism. In particular, transaction costs owing to taxes on new houses and stamp duties are quite heterogeneous across countries. A particularly low tax rate in the United Kingdom is consistent with the high amplitude of its housing market cycle. Within the Euro Area, Germany, Italy and Spain have much smaller transaction costs than the Netherlands, France and Belgium.

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  Economics for Financial Markets

  • Brian Kettell(Author)
  • 2001(Publication Date)
  • Butterworth-Heinemann

    (Publisher)

  3 The term structure of interest rates and financial markets Decisions as to whether to spend or not to spend, whether to borrow (or lend) now or to postpone borrowing (or lending) for six or nine months, whether to buy securities today or hold cash for the present, whether borrowing or lending should be short-term or long-term, are all decisions influenced by current and expected interest rates. Interest rates are at the centre of the key issues in understanding the economics of financial mar-kets. But what are the factors affecting interest rates and what exact role do interest rates play within the financial system? Functions of interest rates Interest rates serve a number of significant functions. First, they provide investors with a guide for allocating funds among investment opportunities. As funds are directed into projects that have higher expected rates of return (risk and other factors being taken into account), the funds are optimally allocated from the viewpoint of both consumer and investor, since the highest returns normally prevail where effective consumer demand is strongest. Unless an investment opportunity prom-ises a return high enough to pay the market rate of interest, it does not justify the required capital outlay. The money market, by channelling funds into projects that have an expected return in excess of the interest rate, provides a valuable service to investors, borrowers, and society as a whole. The interest rate also provides a measure of the relative advantage of current consumption compared to saving. By adjusting the available market rate for expected inflation and 48 Economics for Financial Markets taxes, an individual can determine the real amount of addi-tional future consumption that can be obtained by postponing current consumption. Similarly, interest rates help businessmen decide among alternative production methods. Suppose a product can be made either solely with labour or with a combination of labour and machinery.

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  Handbook of Monetary Economics

  • Benjamin M. Friedman, Michael Woodford(Authors)
  • 2010(Publication Date)
  • North Holland

    (Publisher)

  The contrast arises from the fact that, both at the decision level and for purposes of policy implementation, what most central banks do is set short-term interest rates. In most cases they do so not out of any inherent preference for one interest rate level versus another, but as a means to influence dimensions of macroeconomic activity like prices and inflation, output and employment, or sometimes designated monetary aggregates. But inflation and output are not variables over which the central bank has direct control, nor is the quantity of deposit money, at least in situations considered here. Instead, a central bank normally exerts whatever influence it has over any or all of these macroeconomic magnitudes via its setting of a short-term interest rate.

  At a practical level, the fact that setting interest rates is the central bank’s way of implementing monetary policy is clear enough, especially now that most central banks leave abandoned or at least downgraded the money growth targets that they used to set. (This happened mostly during the 1980s and early 1990s, although some exceptions still remain.) The centerpiece of how economists and policymakers think and talk about monetary policy is now the relationship directly between the interest rate that the central bank fixes and the economic objectives, such as for inflation and output, that policymakers are seeking to achieve. (Further, even when central banks had money growth targets, what they mostly did in an attempt to achieve them was set a short-term interest rate anyway.)

  This key role of the central bank’s policy interest rate is likewise reflected in what economists write and teach about monetary policy. In place of the once ubiquitous Hicks-Keynes “IS-LM” model, based on the joint satisfaction of an aggregate equilibrium condition for the goods market (the “IS curve”) and a parallel equilibrium condition for the money market for either given money supply or a given supply of bank reserves supposedly fixed by the central bank (the “LM curve”), today the standard basic workhorse model used for macroeconomic and monetary policy analysis is the Clarida-Galí-Gertier “new Keynesian” model consisting of an IS curve, relating output to the interest rate as before but now including expectations of future output too, together with a Phillips-Calvo price-setting relation. The LM curve is gone, and the presumption is that the central bank simply sets the interest rate in the IS curve. The same change in thinking is also reflected in more fundamental and highly elaborated explorations of the subject. In contrast to Patinkin’s classic treatise (1956 , with an important revision in 1965) , Money, Interest, and Prices , Woodford’s 2003 treatise is simply Interest and Prices

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  Handbook of Singapore — Malaysian Corporate Finance

  • Tan Chwee Huat, Kwan Kuen-Chor, Tan Chwee Huat, Kwan Kuen-Chor(Authors)
  • 2014(Publication Date)
  • Butterworth-Heinemann

    (Publisher)

  Research in developed economies suggests that economic activities go through periodic expansions and contractions. Demand for credit is particularly high during the peaks of the cycles, and depressed prior to the trough. Certain economic indicators, for example the stock market and the money supply, are early indicators of the turnaround in business cycles: these are called leading indicators. 9. Financial analysts are usually observant about these fundamental economic forces. Correct predictions of the changes in such fundamental forces will enable one to anticipate likely changes in interest rates. Practical Guide to Interest Rate Determination 55 In the Singapore market, as in other markets, there are significant spreads between the yields of different securities. Conceptually it is useful to consider the total yield or interest rate at a given time, in contrast to that over a period of time, for determining a trend as consisting of three components a, b and c. Interest! = (Time valuei , rMarket-widei , rSecurity-relevanti rate J I of money J I factors J I factors J Equation 3.3 i = a + b + c The time value of money is determined by two important factors operating in every economy: the long-term real productivity (i*) of the economy and the rate of change in the price levels (purchasing power) in the economy. The change in the marketwide factor is determined by the cyclical trend operating over a short period, and the demand for and supply of loanable funds. When interest rates (yields) decline, an existing holder of, say, a bond will experience a price gain for the bond but suffer a loss in income from reinvestment of coupons from bond at the lower interest rates. This marketwide effect can also be termed the interest rate risk that affects all securities. The issuer-relevant factors are related to the nature of the firm or government that issues the security.

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