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With positive trend inflation, the Taylor principle is not enough to guarantee adeterminate equilibrium. We provide new theoretical results on restoring determinacy inNew Keynesian models with positive trend inflation and combine these with newempirical findings on the Federal Reserve’s reaction function before and after theVolcker disinflation to find that 1) while the Fed likely satisfied the Taylor principle in thepre-Volcker era, the US economy was still subject to self-fulfilling fluctuations in the1970s, 2) the US economy moved from indeterminacy to determinacy during theVolcker disinflation, and 3) the switch from indeterminacy to determinacy was due to thechanges in the Fed’s response to macroeconomic variables and the decline in trendinflation during the Volcker disinflation.

The paper uses historical data on interest rates from 1920 to 2016 to explore whether a world rate of interest exists and whether a monetary hegemon affects it. The first principal component of long-term interest rates accounts for 75% of the variation in a matrix of 17 countries and proxies for the world rate of interest. The U.S. played the role of a hegemon, influencing long-term bond rates. After the introduction of the euro in 1999, interest rates in most European countries followed German interest rates but German rates followed U.S. rates even more than before the introduction of the euro. In two countries on the northern periphery, Denmark and Sweden, interest rates shadow German rates and the low rates have contributed to rising house prices and rising mortgage debt. Independent monetary policy calls for targeted controls on capital flows. [ABSTRACT FROM AUTHOR]

The essence of monetary hegemony is the power of one monetary authority to influence monetary conditions outside its jurisdiction. Such power did not exist under the gold standard but came into existence for the U.S. Federal Reserve in the aftermath of the First World War. The basis of that power was the massive drain of gold out of Europe into the U.S. during its period of neutrality and the scope for the newly created Federal Reserve to pursue a discretionary monetary policy with specific aims such as stable prices, rapid recovery from recession, and countering pullbacks in the equity market. Throughout its 100-year exercise of monetary hegemony, the U.S. has used this in ways that have spread inflation around the globe, both goods inflation and asset inflation. Both the U.S. and the rest of the world would have benefited from a U.S. monetary hegemon based on sound money principle rather than on inflationary finance. [ABSTRACT FROM AUTHOR]

Gaussian affine term structure models attribute time‐varying bond risk premia to changing risk prices driven by the conditional means of the risk factors, while structural models with recursive preferences credit it to stochastic volatility. We reconcile these competing channels by introducing a novel form of stochastic rate of time preference into an otherwise standard model with recursive preferences. Our model is affine and has analytical bond prices making it empirically tractable. We use particle Markov chain Monte Carlo to estimate the model, and find that time variation in bond term premia is predominantly driven by the risk price channel. [ABSTRACT FROM AUTHOR]

This paper revisits the question of interest rate pass-through from the federal funds rate to bank and open market rates from the years 1987 to 2015. We employ cointegration tests with improved testing power by using information in non-normal errors. Using this approach, we find evidence of cointegration between the federal funds rate and the prime rate, the federal funds rate and the 3-month financial commercial paper rate, but no evidence of cointegration between the federal funds rate and the 30-year conventional mortgage rate. Moreover, we estimate the degree of long-run pass-through for both the prime and commercial paper rates to be less than one. Our results confirm that there is not only significant co-movement between the federal funds rate and short-term borrowing rates, but also that interest rate pass-through, in the long run, is incomplete. [ABSTRACT FROM AUTHOR]

This paper examines the relationship between interest rates and household saving rates for an uneven panel of 19 OECD countries during the period 1995–2018. Unlike earlier studies, it uses the pooled mean group methodology to investigate which of the interest rate effects, income or substitution, dominates in the short run, long run, or both periods. With the baseline estimations, I find that the income effect outweighs the substitution effect in the short run, and vice versa in the long run. I also find that inflation (both expected and actual), household wealth through housing prices, unemployment rate, current taxes on income and wealth, and general government debt have significant negative impact on household saving in the long run. I find that financial development has a positive effect on household saving in the long run. Current taxes on income and wealth have a strong negative impact on household saving in the short run. [ABSTRACT FROM AUTHOR]

An on-going period of secular stagnation in advanced economies has brought down interest rates, growth rates and inflation. Due to the relatively larger fall in interest rates, the differential between the interest rate paid on government debt and the output growth rate (IRGD) became lower and has even turned negative in most advanced economies. In such an environment, public debt may come at much lower (or even no) cost. Thus, if this pattern remains stable, it has important implications on the role of fiscal policy. Against this background, this paper discusses relevant long-term trends in Europe and aims to explain the currently low IRGD. Furthermore, it investigates possible future IRGD paths and its consequences for fiscal policy. [ABSTRACT FROM AUTHOR]

At the zero lower bound, the dynamic Nelson–Siegel (DNS) model and even the Svensson generalization of the model have trouble in fitting the short maturity yields and fail to grasp the characteristics of the Japanese government bonds (JGBs) yield curve. During the zero interest rate policy regime, the short end of the yield curve is flat and yields corresponding to various maturities have asymmetric movements. Therefore, closely related generalized versions of Nelson–Siegel model—with and without no-arbitrage restriction (GAFNS and GDNS)—that have two slopes and curvatures factors are considered and compared empirically in terms of in-sample fit as well as out-of-sample forecasts with the standard Nelson–Siegel model—with and without no-arbitrage restriction (AFNS and DNS). The affine-based models provide a more attractive fit of the yield curve than their counterpart DNS-based models. Both extended models are capable to restrict the estimated rates from becoming negative at the short end of the curve and distill the JGBs term structure of interest rate quite well. The affine-based extended model leads to a better in-sample fit than the simple GDNS model. In terms of out-of-sample accuracy, both non-affine models outperform the affine models at least for 1- and 6-month horizons. The out-of-sample predictability of the GDNS for the 1- and 6-month-ahead forecasts is superior to the GAFNS for all maturities, and for longer horizons, i.e., 12-month-ahead, the former is still compatible to the latter, particularly for short- and medium-term maturities. [ABSTRACT FROM AUTHOR]

Term structure drivers of 1‐year bond premia and conditional bond return risk are distinct. Consequently, the Cochrane–Piazzesi factor captures aggregate price of risk and not the amount of risk in 1‐year bond returns. One linear combination of forward rates captures most of the variation in bond return risk across maturities. Interest rate level captures substantial amount of variation in the conditional return risk, a finding consistent with rising inflation uncertainty with level of inflation and interest rates. The 4‐5 yield spread, an important positive predictor of bond return premia, has an opposing but limited impact on the conditional volatility. [ABSTRACT FROM AUTHOR]

This paper examines the nexus between inflation and central bank interest rate policies in inflation-targeting countries. First, it looks at the role of inflation among other factors affecting monetary policy. Second, it looks at the drivers of inflation alone. Thereby, the role of international spillovers from other countries is explicitly regarded as well, with the aim of assessing the extent to which inflation is driven by other countries' inflation or monetary policy is influenced by other economies. The empirical study covers advanced countries and emerging market economies for the period 1995 - 2016 and uses Bayesian global vector autoregression to model external linkages and to account for variable uncertainty. This study finds that inflation plays an important role for monetary policy. More importantly, central banks clearly consider additional factors and notably other countries' key indicators when setting interest rates. Inflation in turn is determined by both internal and external factors like the exchange rate and other countries' inflation. These findings are much more comprehensive than previous literature and demonstrate that central banks consider a multitude of domestic and global factors. [ABSTRACT FROM AUTHOR]

I analyze real interest rate convergence among six industrialized countries in 1975M1–2011M3 within a multi-country framework by means of a dynamic latent factor model. This approach makes it possible to examine common trending behavior and common transitory movements in the real interest rates. Time-varying variances of the components allow for gradual endogenous transition from a high variance regime toward a low variance regime. The estimation results suggest that four permanent and four transitory components capture the real interest rate dynamics among the sample of G7 countries at the beginning of the sample period. The common components' variances mostly decline over time, and in part even converge to values close to zero. This indicates a reduction in the number of stochastic factors, which in turn can be interpreted as confirmation of the convergence hypothesis of less cross-country dispersion over time. I observe rapid convergence during the late 1970s and 1980s, followed by slower transition since the beginning of the 1990s when financial markets had already been highly integrated. [ABSTRACT FROM AUTHOR]

It is well known that zero coupon rates are not observable variables. Their estimation process may be cumbersome and time consuming. We explore the extent to which the set of security prices used in the yield curve construction of three popular interest rate datasets (from the Federal Reserve Board, the US Department of the Treasury, and Bloomberg) may determine the results of different analyses. Using the same US Treasury prices from GovPX and applying the same fitting technique, we estimate zero coupon rates using different baskets of assets, i.e., including/excluding bills, on-the-run, and off-the-run bonds, attempting to mimic those used by each data providers. To illustrate the uncertainty surrounding these alternatives representations of the underlying yield curve, we examine common uses of these data sets in pricing, risk management and macroeconomic purposes. We find significant and sometime overwhelming differences in the volatility term structure, the pricing of interest rate derivatives, and the correlations among different forward rates particularly in both ends of the yield curve. Relevant implications are also observed on a classic test of the expectations hypothesis. The simplest asset basket, which only includes the on-the-run bills and bonds, is probably the one with the best results. [ABSTRACT FROM AUTHOR]

This paper investigates the effects of monetary policy shocks and uncertainty about monetary policy on key macroeconomic variables and interest rate spreads — the term spread and credit spread. We use monthly data for the United States and a multivariate structural GARCH-in-Mean VAR model to estimate the effects on the growth rate of real output, the inflation rate, term spread, credit spread, and the policy rate. We find statistically significant effects on all economic and financial variables. [ABSTRACT FROM AUTHOR]

Previous studies attribute the failure of the expectations theory, using the 3–6-month Treasury bill spread, to the Federal Reserve's commitment to stabilizing interest rates. We find that with the advent of Greenspan, this spread predicts future changes in the short rate in the USA. This success can be explained by interest rate smoothing and greater transparency by the Fed. By enhancing the management of market expectations and reducing uncertainty, the central bank improves interest rate predictability and gains credibility from the market, as lower term premia suggest. [ABSTRACT FROM AUTHOR]

We re-examine the validity of the expectation hypothesis (EH) of the term structure for the Brazilian fixed income market, using data from January 2000 to June 2017. Furthermore, we investigated the out-of-sample predictability of bond excess returns by means of common factors extracted from a cross-section of Brazilian macro-variables and zero-coupon interest rates. The EH is rejected throughout the term structure examined on the basis of the statistical tests across the entire maturity spectrum considered. Our results confirm previous findings, mostly obtained for developed markets, that a linear combination of forward rates and macroeconomic factors can explain a substantial portion of movements in bonds excess returns, contributing novel and up-to-date evidence from a large and dynamic emerging bond market, such as Brazil. Furthermore, we find that the factor extracted from a large panel of macroeconomic variables generates significant gains in forecasting bond excess returns relative to yield curve information. [ABSTRACT FROM AUTHOR]

This article analyzes whether there are asymmetric relations between real interest rates and agricultural commodity prices using quarterly data of US interest rates and agricultural commodity prices over the period of 1983q1–2014q4. While the literature has identified statistically significant negative relations between real interest rates and agricultural commodity prices, this article extends the analysis by testing for threshold effects using Hansen's (J Econom 93(2):345–368. 10.1016/S0304-4076(99)00025-1, 1999) fixed-effect panel threshold model and testing procedure. The empirical results indicate that real interest rates and agricultural commodity prices follow a U-shaped relationship, with − 1.45 being the turning point from negative to positive effects. Specifically, if real interest rates below the threshold of − 1.45 are increased by 1%, agricultural commodity prices will decrease by 8.1%, and if real interest rates are equal or above − 1.45 and are increased by 1%, agricultural commodity prices will increase by 3.4%. As the literature suggests an inverse proportional relation between real interest rates and agricultural commodity prices, a theoretical explanation for this phenomenon has yet to be found but is probably related to assumptions about market participants' expectations and risk behavior. [ABSTRACT FROM AUTHOR]

We use a panel rank cointegration approach to check for the stability conditions of the cross-country money market interest rate basis. Using weekly information on short-term interest rates and spot and forward exchange rates for a set of 20 European economies between 2005 and 2017, we show that in most cases these bases are non-stationary, implying the failure of the covered interest rate parity condition. Concretely, a mean-reverting behavior is encountered in only two cases. The first includes Greece, Italy and Portugal, while the second Belgium, France and Germany. [ABSTRACT FROM AUTHOR]

This paper studies the nonlinear response of the term structure of interest rates to monetary policy shocks and presents a new stylized fact. We show that uncertainty about monetary policy changes the way the term structure responds to monetary policy. A policy tightening leads to a significantly smaller increase in long‐term bond yields if policy uncertainty is high at the time of the shock. We also look at the decomposition of bond yields into expectations about future policy and the term premium. The weaker response of yields is driven by the fall in term premia, which fall more strongly if uncertainty about policy is high. Conditional on a monetary policy shock, higher uncertainty about monetary policy tends to make securities with longer maturities relatively more attractive to investors. As a consequence, investors demand even lower term premia. These findings are robust to the measurement of monetary policy uncertainty, the definition of the monetary policy shock, and to changing the model specification. [ABSTRACT FROM AUTHOR]

Shadow short rate (SSR) estimates are generated regressors proposed as a proxy for policy interest rates during unconventional monetary policy (UMP) periods. However, using the Wu and Xia (2016) shadow/lower‐bound model, I show that SSR estimates can be sensitive to minor choices in their estimation. Used subsequently in a small macroeconomic model, those sensitivities lead to wide variations in the inferred effects of UMP on inflation and unemployment outcomes. Therefore, it should not be presumed that any SSR series will necessarily be quantitatively useful. Vetting SSR series allows appropriate SSR series to be retained within the suite of UMP indicators. [ABSTRACT FROM AUTHOR]

While the research linking interest rates to government deficits is extensive, the impact of other tax-related variables is uncommon. This study seeks to add to the literature on credit markets by exploring the impact of not only the budget deficit but also average effective personal income tax rates and personal income tax evasion as explanatory variables. To the best of our knowledge this study is the first study to recognize the joint importance of all of these fiscal variables. We utilize data covering the post-Bretton Woods period from 1971 through 2016 to analyze the impact of the three variables in order to shed light on the spread between the real interest rate yields on Moody's Aaa-rated corporate bonds and high quality municipal bonds. Estimations reveal that the higher the average effective federal personal income tax rate, the greater the differential between the yields on corporate bonds and tax-free Municipals. Furthermore, it is found that the higher the adjusted gross income gap, the greater the real yield spread between Moody's Aaa-rated corporate bonds and high quality municipal bonds. Finally, the greater the primary budget deficit, the greater the spread as well. [ABSTRACT FROM AUTHOR]

It is often purported that the ECB's ultra-loose monetary policy significantly affects household income and financial wealth. Considering selected euro area countries, this paper addresses two questions: first, how did households net interest income develop in recent years? Second, did portfolio structures change? Based on recently extended national accounts data, I derive stylised facts suggesting that net interest income indeed changed with monetary policy. However, patterns differ across countries. Whereas households in some countries suffered from declining incomes, in other countries they achieved incomes which, considered in real terms, were substantially higher than before. Tentative links to household balance sheets and their interest rate fixation suggest that these factors outweigh the significance of monetary policy. Regarding portfolios, however, less divergence is observed. Risk-taking did not increase in any country, despite the low yields of safe assets. General statements claiming that the ECB's monetary policy has solely negative effects for household finances therefore seem to be inadequate. [ABSTRACT FROM AUTHOR]

We use wavelet analysis to study the relationship between the yield curve and macroeconomic indicators in Canada. We rely on the Nelson–Siegel approach to model the zero-coupon yield curve and use the Kalman filter to estimate its time-varying factors: the level, the slope and the curvature. Apart from establishing a bidirectional yield–macro relation, the paper broadens the existing literature by exploring the link between the monetary policy and the yield curve. We reached several conclusions. First, the monetary policy variable, the bank rate, affects mainly short-run interest rates. Arguably, the main driver for economic activity is the long-run interest rate (instead of the short run), suggesting that monetary policy is mostly ineffective. Second, we concluded that concerning the inflation rate, the Bank of Canada is very proactive. Third, regarding the unemployment rate, we found that both the slope and the curvature are leading indicators for the long-run evolution of unemployment. Finally, our results suggest that the industrial production index leads the yield curve factors and not the other way. [ABSTRACT FROM AUTHOR]

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We develop a general term structure framework taking stochastic discontinuities explicitly into account. Stochastic discontinuities are a key feature in interest rate markets, as for example the jumps of the term structures in correspondence to monetary policy meetings of the ECB show. We provide a general analysis of multiple curve markets under minimal assumptions in an extended HJM framework and provide a fundamental theorem of asset pricing based on NAFLVR. The approach with stochastic discontinuities permits to embed market models directly, unifying seemingly different modelling philosophies. We also develop a tractable class of models, based on affine semimartingales, going beyond the requirement of stochastic continuity. [ABSTRACT FROM AUTHOR]

In the study of mortgage loan pricing, prepayment and default hazards are considered. While default results in loss of initial capital, prepayment is the more frequent termination event. This study makes a distinction between pecuniary and non-pecuniary prepayments in the mortgage pricing model. Pecuniary/non-pecuniary prepayments are distinguished from each other based on whether the market interest rate at prepayment is below/above the rate at origination, and thus whether mortgage lenders/investors can reinvest the proceeds at a lower/higher interest rate using the proceeds from a prepaid loan. Using a sample of 30-year fixed-rate mortgage loans for home purchase, this study finds that pecuniary and non-pecuniary prepayments are affected differently by certain overlapping factors and are driven by some unique factors. The results also show that combining these two types of prepayments into a single prepayment measure may yield inaccurate predictions of loan termination probabilities. The results from the mortgage pricing model indicate that pecuniary and non-pecuniary prepayment risks, together with default risk, contribute separately to the pricing of a loan. [ABSTRACT FROM AUTHOR]

We study monetary policy implementation through an operating regime involving voluntary reserve targets (VRTs). Operating regimes based on reserve requirements may lead to a collapse in interbank trade, as they have since the financial crisis. We show that, no matter the abundance of reserves, VRTs encourage market activity and support the central bank's control over interest rates. We consider (i) the impact of anticipated and unanticipated liquidity injections by the central bank on market outcomes and (ii) a comparison with the implementation framework currently adopted by the Federal Reserve. Overall, a VRT framework may provide several advantages over other frameworks. [ABSTRACT FROM AUTHOR]

To analyze monetary policy implementation in a negative rate environment, we add the option to exchange central bank reserves for cash to the standard workhorse model of monetary policy implementation (Poole 1968). Importantly, we show that monetary policy can be constrained when the target overnight rate is below the yield on cash. At this point, the overnight rate equals the yield on cash instead of the target rate. Modifications to the implementation framework, such as a reserve requirement that varies with cash withdrawals, can help restore the implementation of monetary policy such that the overnight rate equals the target rate. [ABSTRACT FROM AUTHOR]

This paper shows how interbank market fragmentation disrupts the transmission of monetary policy. Fragmentation is the fact that banks, depending on their country of location, have different probabilities of default on their interbank borrowings. Once fragmentation is introduced into standard theoretical models of monetary policy implementation, excess liquidity arises endogenously. This leads short‐term interest rates to depart from the central bank policy rates. Using data on monetary policy operations, I show that this mechanism has been at work in the euro area since 2008. The model is used to analyze conventional and unconventional monetary policy measures. [ABSTRACT FROM AUTHOR]

We study the dynamic relation between sovereign yield curve and external shocks driven by global uncertainty and capital inflows. A Nelson–Siegel model is estimated to capture the three latent factors of the yield curve corresponding to level, slope and curvature. The state-space representation of the model is used to document the dynamic relation between the factors of the yield curve, the domestic macroeconomic variables (capacity utilization ratio, inflation, and monetary policy rate) and the external factors (global risk perception and capital flows). We find that although domestic macroeconomic variables have some impact on the future shape of the yield curve, the impact is becoming weaker after the 2008 global financial crisis. The results suggest that external factors emerge to have sizeable and significant impact on both macroeconomic variables and the latent factors. These results have important policy implications for policymakers especially for central bankers and debt managers when capital flows have been a major concern after the 2008 global financial crisis. [ABSTRACT FROM AUTHOR]

This paper analyzes Milton Friedman's (1968a) article "The Role of Monetary Policy," via a discussion of seven fallacies concerning the article. These fallacies are as follows: (i) "The Role of Monetary Policy" was Friedman's first public statement of the natural rate hypothesis. (ii) The Friedman–Phelps Phillips curve was already present in Samuelson and Solow's (1960) analysis. (iii) Friedman's specification of the Phillips curve was based on perfect competition and no nominal rigidities. (iv) Friedman's (1968a) account of monetary policy in the Great Depression contradicted the Monetary History's version. (v) Friedman (1968a) stated that a monetary expansion will keep the unemployment rate and the real interest rate below their natural rates for two decades. (vi) The zero lower bound on nominal interest rates invalidates the natural rate hypothesis. (vii) Friedman's (1968a) treatment of an interest‐rate peg was refuted by the rational expectations revolution. The discussion lays out the reasons why each of these seven items is a fallacy and infers key aspects of the framework underlying Friedman's (1968a) analysis. [ABSTRACT FROM AUTHOR]

Since 2012 several central banks have introduced a negative interest rate policy (NIRP) aimed at boosting real spending by facilitating an increase in the supply and demand for bank loans. We employ a bank-level dataset comprising 6558 banks from 33 OECD member countries over 2012–2016 and a matched difference-in-differences estimator to analyze whether NIRP resulted in a change in bank lending in NIRP-adopter countries compared to those that did not adopt the policy. Our results suggest that following the introduction of negative interest rates, bank lending was weaker in NIRP-adopter countries. The result is robust to a wide range of checks. This adverse NIRP effect appears to have been stronger for banks that were smaller, more dependent on retail deposit funding, less well capitalized, had business models reliant on interest income, and operated in more competitive markets. [ABSTRACT FROM AUTHOR]

The paper investigates the exchange rate on the reaction function of 24 emerging markets economies' (EMEs) central banks from 2000Q1 to 2015Q2. This is done by first employing fixed-effects (FE) ordinary least squares and then system generalized methods of the moments techniques. Under FE, the exchange rate is important in the reaction function of EMEs. Allowing for the endogeneity of inflation, output gap, and the exchange rate, the exchange rate remains positive and statistically significant (but quantitatively less) across inflation targeting countries. When the sample is partitioned into targeting and non-targeting countries, the exchange rate remains relevant in the reaction function of non-targeters. The results remain robust to splitting the sample at the time of the financial crisis of 2007–2009 and suggest that, after the crisis, central banks of EMEs respond only to inflation movements in the interest rate reaction function. [ABSTRACT FROM AUTHOR]

This paper studies the predictive power for recessions of the slope of the Swiss term structure using monthly data for 1974–2017. Dynamic probit models indicate that the term structure contains information useful for predicting recessions for horizons up to 19 months. Whether the economy is currently in recession or not is also useful for forecasting recessions. These relationships prove stable over the sample. Robustness tests indicate that the KOF business course indicator and some monetary aggregates contain different information from the term structure which can improve the in- and out-of-sample fit of the model. [ABSTRACT FROM AUTHOR]

Evidence in favour of the ability of the term spread to forecast economic growth of the South African economy is non-existent. This could be due to the term spread aggregating information contained in the expected spread and the term premium. To decompose the term spread into its subcomponents, we develop an estimable small open economy new Keynesian dynamic stochastic general equilibrium (SOENKDSGE) model of the inflation targeting South African economy. The SOENKDSGE model is estimated with Bayesian methods over the quarterly period of 2000:01–2014:04. We then use a linear predictive regression framework to analyse the out-of-sample forecasting ability of the aggregate term spread, as well as the expected spread and term premium. Our forecasting results fail to detect forecasting gains from the aggregate term spread and also the term premium, but the expected spread is found to contain important information in forecasting output growth over short- to medium-run horizons, over the period of 2004:01–2014:04, using an in-sample period of 2000:01–2003:04. The results therefore highlight the importance of the forward-looking component of the term spread—the expected spread—in forecasting the output growth of South Africa. [ABSTRACT FROM AUTHOR]