CAPITAL CONTROL AND DOMESTIC INTEREST RATES: A GENERALIZED MODEL

This article addresses the question of capital control (inflow) and its varied effect on interest rates and real-side economy. The moral hazard problem causes interest rates to increase as a function of external debt. Decreased capital inflow (external debt) can reduce moral hazard and outweigh the effect of costly capital transactions, with capital control decreasing interest rates and increasing output. This result runs counter to other theoretical works on capital control. The policy implication is that a government can generate national gains from capital inflow control by prohibiting new external debt (borrowing from abroad). With old debt retired and no new borrowing from abroad, external debt is reduced. This will reduce the moral hazard problem and lead to a drop in interest rates and an increase in output. (JEL F32 , F41 , E43 )     

MONETARY POLICY AND LONG-TERM INTEREST RATES

Movements in long-term interest rates Granger-cause movements in the target federal funds rate, but not vice versa, during 1990–2001. This implies that changes in the monetary policy stance, as measured by the target rate, are predicted by the bond market. Moreover, even innovations to the target rate have little effect on long-term interest rates. The policy instrument seems to be responding to information that is already impounded in the bond market. In sharp contrast, during an earlier period, changes in the target federal funds rate are mostly unanticipated by the bond market, and innovations to the policy target have a large and significant effect on long-term interest rate. ( JEL E52, E43)     

SOME EVIDENCE ON MEAN REVERSION IN EX ANTE REAL INTEREST RATES

Ex ante real interest rates and their differentials are tested for mean reversion using quarterly data on three-month treasury bill rates and consumer prices for 12 major industrial countries over the period 1972:l-1993:3. The results are strongly supportive of mean reversion, particularly when less conventional tests are employed. The conclusion that can be derived from the empirical evidence is that goods, capital and foreign exchange markets have become highly integrated in the countries under consideration.     

NOMINAL BONDS AND INTEREST RATES*

In this article, I integrate the microfoundation of monetary theory with the model of limited participation to analyze the competition between nominal bonds and money. The market for government nominal bonds is centralized and Walrasian, whereas the goods market is modeled as random matches. The government imposes a legal restriction that requires all government goods to be purchased with money but not with bonds. By contrast, private agents can exchange between themselves with both money and bonds. I show that an arbitrarily small legal restriction is sufficient to prevent matured bonds from being a medium of exchange. I also analyze the effects of monetary policy with and without the legal restriction. Some of those effects differ significantly from traditional monetary models.     

MONETARY POLICY AND LONG-TERM INTEREST RATES: A SURVEY OF EMPIRICAL LITERATURE

This paper surveys recent empirical literature on effects of monetary policy on long-term interest rates. Most studies reviewed here suggest that tightening monetary policy results in higher long-term interest rates. But available evidence suffers from conceptual and empirical problems and fails to indicate the magnitude of short-run and long-run policy effects on long rates. Also, recent studies have not investigated the possibility of shifts in recent-year effects of monetary policy on long rates. Finally, the paper offers a policy perspective on limitations of existing evidence and suggests future research on monetary policy effects on long rates.     

THE MISSING LINK BETWEEN INFLATION UNCERTAINTY AND INTEREST RATES

In the literature, there is no consensus about the direction of the effects of inflation uncertainty on interest rates. This paper states that such a result may stem from differentiation in the sources of the uncertainties and analyzes the effects of different types of inflation uncertainties on a set of interest rates for the UK within an interest rate rule framework. Three types of inflation uncertainties – impulse uncertainty, structural uncertainty and steady‐state uncertainty – are derived by using a time‐varying parameter model with a Generalized Autoregressive Conditional Heteroskedasticity specification. It is shown that the impulse uncertainty is positively and the structural uncertainty is negatively correlated with the interest rates. Moreover, these two uncertainties are important to explain short‐term interest rates for the period of inflation targeting era. However, this time, the impulse uncertainty is negatively and the structural uncertainty is positively correlated with the overnight interbank interest rates, which is consistent with the general characteristic of the inflation targeting regimes. Lastly, the evidence concerning the effect of the steady‐state inflation uncertainty on interest rates is not conclusive.     

THE TEMPORAL CAUSALITY BETWEEN FISCAL DEFICITS AND INTEREST RATES

Conventional wisdom suggests that higher government fiscal deficits cause higher (long-term) interest rates. Much empirical work—generally standard ordinary least squares (OLS) regression analysis—has examined this issue and has produced mixed findings. Even if these standard OLS studies conclude that deficits and interest rates are related, they do not answer the question of which came first—the higher deficit or the higher interest rate? A few studies have used Granger causality to consider the question of temporal causality, generally with short-term interest rates. Tliis paper employs the relatively new cointegration and error-correction methodology to reexamine the temporal causality between fiscal deficits and interest rates—both long term and short term. This study finds evidence that federal deficits cause the long-term interest rate.     

INTEREST RATES, RATE SPREADS, AND ECONOMIC ACTIVITY

Interest rates and the spreads between interest rates are widely regarded as useful indicators of the future level of economic activity. This paper shows that when these series are divided into (i) an ordinary time series process and (ii) the effects of extraordinary disturbances, only the extraordinary disturbances predict economic activity. These disturbances are associated with periods of monetary policy intervention. Most of the predictive power is in contractionary disturbances that have persistent effects over time. The results imply that the predictive power of interest rates comes primarily from periods of contractionary monetary policy and is not due to ordinary movements in interest rates.     

EFFECTS ON INTEREST RATES OF IMMEDIATELY RELEASING FOMC DIRECTIVES

Prior to February 1994, the Federal Open Market Committee (FOMC) did not officially release its current Domestic Policy Directives to the public until after the next FOMC meeting, a lag of approximately 45 days. Thus, the public never knew the FOMC's latest decisions about short-run monetary policy. On 11 occasions between early 1989 and May 1993, however, the essence of the directives was "leaked" to the Wall Street Journal within one week of an FOMC meeting. This study tests Federal Reserve officials' original assertion that early release of directives would increase volatility in financial markets by creating announcement effects. The study finds some evidence of announcement effects in certain instances, but the assertion that an immediate release would "roil the markets" appears unfounded .     

UNOFFICIAL EXCHANGE RATES IN BANGLADESH: A COINTEGRATION ANALYSIS

This article estimates a structural model for unofficial market foreign exchange (forex) rates (E U ) and examines the stability of the forex market in Bangladesh using an autoregressive distributed lag approach to cointegration analysis on quarterly data from 1976Q2–1995Q2. It also compares the in-sample and out-of-sample (from 1995Q3–1999Q2) forecasting performances of the structural model with other timE-series models. With E U as a dependent variable and official exchange rates (E O ) , money supply (M) , the difference between foreign and domestic interest rates (I) , forex reserves relative to imports (Q) and political along with some structural factors (D85) as explanatory variables, a multivariate cointegrated relationship is found in which E O , Q , and I cause an appreciation and M and D85 cause a depreciation in E U . These results imply that the overvaluation of the official exchange rate, increases in money supply, the paucity of official forex reserves, and structural factors are the main causes for the creation of the unofficial market for forex in Bangladesh. Results also reveal that the forex market in Bangladesh is stable during the sample period. The structural model performs well in in-sample prediction, and the random walk model performs best in out-of-sample forecasting.