Interest-rate Stability

3 Key excerpts on "Interest-rate Stability"

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  eBook - ePub

  Macroeconomic Policy and Steady Growth in China

  2020 Dancing with Black Swan

  • Zhang Xiaojing(Author)
  • 2021(Publication Date)
  • Routledge

    (Publisher)

  They question not only the ability of central banks to adjust the interest rate toward the equilibrium level, but also the very rationale of the so-called equilibrium interest rate itself. They point out that, when the inflation indicator is no longer sensitive, there is no longer a basis for central banks’ adjustment of interest rate. They further point out sharply that the logic of the secular stagnation theory is flawed: if low equilibrium interest rate leads to financial instability, is this instability-causing interest rate really an “equilibrium” interest rate? 20 That is to say, is the combination of high debt and low interest stable and consistent? The financial cycle theory argues that monetary policy and financial cycle should be taken into consideration in the determination of the equilibrium interest rate. 21 A lot of empirical research shows that, compared with inflation, credit and asset prices contain more information about future output. This means that we need to incorporate the financial cycle, and not just inflation, into monetary policy targets. Otherwise, as many research point out, monetary policy will add to financial instability by encouraging the accumulation of financial vulnerabilities, and then add to the downward risk of the real economy in the future. Borio et al. discovered that the “finance-neutral” equilibrium interest rate, which takes the financial cycle into account, is higher than the traditional equilibrium. And the current low interest rate can be more attributed to the accumulation of ill-advised monetary policies in the past. 22 Central banks face a trade-off between short-term and long-term output. A higher policy rate facilitates a strong financial sector and ensures long-term economic development and stability at the price of higher cost of funding for banks and lower short-term economic activity

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  Financial Institutions

  Markets and Money

  • David S. Kidwell, David W. Blackwell, David A. Whidbee, Richard W. Sias(Authors)
  • 2020(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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  Banking on the Future

  The Fall and Rise of Central Banking

  • Howard Davies, David W. Green(Authors)
  • 2010(Publication Date)
  • Princeton University Press

    (Publisher)

  However, external stability in the form of an exchange rate regime, even though it is intimately linked with monetary policy, is quite often the direct responsibility of government, although they may delegate operational decisions and actions to the central bank. Finan-cial stability is a more elusive concept, to which we return later, but 23 C H A P T E R T W O it is as often associated with the responsibilities of supervisory agen-cies as with those of central banks. Nevertheless, failure to achieve any one of the objectives may adversely affect the other two, and trade-offs between them are sometimes inevitable. Certainly, with only one main instrument, the short-term interest rate, a central bank can focus primar-ily on either domestic stability or the external stability of the currency, but not on both simultaneously. Whether this single tool can or should be used for the purpose of influencing both domestic price stability and financial stability is a more disputed question, as we shall see, but it certainly has an impact on both. Here we sketch out the historical background to the central bank response to the crisis. The latter precipitated a major rethink of the tech-niques through which monetary policy is given effect, and whose conse-quences are likely to be far-reaching. The background is of interest, as a number of the techniques and approaches now being revisited are close cousins of those which have been used in the past and, for a variety of reasons, set aside. What follows should be seen as a rough guide to the main strands of thinking about monetary policy implementation, which have waxed and waned remarkably in recent decades. Domestic Price Stability It is not entirely clear when central banks first consciously started to conduct what is now called “monetary policy,” in the sense of taking deliberate action to use their balance sheets to achieve some wider eco-nomic purpose, often through setting the short-term interest rate.

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