In response to a temporary increase in government purchases, the contemporaneous short-term rate falls while some forward rates rise.... The Model.[r]

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The importance of these anticipatory influences can perhaps be illustrated by the rise in **real** **rates** during 1994. The magnitude and timing of this rise was very difficult to explain in many countries by any specific event. However, it is plausible that the longer-term prospects for saving and investment balances may have changed significantly, prompting adjustments in **real** **rates**. One possible culprit was the absence of fiscal consolidation in several countries despite improved economic conditions, signalling possible future domestic saving pressures. On a more positive note, several countries may have good reason to expect higher future returns on investment, following significant structural adjustment policies and, to some extent, higher **real** **interest** **rates** might reflect increases in expected future profitability. Consistent with globally integrated capital markets, the transmission of **real** rate movements from larger to smaller countries -- for example, responses to the monetary policy tightening in the United States -- also played a significant role. In sum, given that **real** **interest** **rates** are determined so as to equilibrate ex ante saving and investment, for estimation purposes it is useful to separate their determinants into low-frequency and high-frequency components. Low-frequency determinants can be thought of as the fundamentals that influence saving and investment trends, while high-frequency determinants are those which proxy the movements in expectations about these fundamental factors. In this framework, it is plausible that the low-frequency fundamentals operate consistently in all countries (i.e. they have equal coefficients across countries), while expectation’s formation varies across countries, given that agents are anticipating country-specific developments.

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The data are of monthly frequency and cover two countries namely Malaysia and Singapore are included in this study and covers the 1977Q1 – 2005Q3 period. The nominal **interest** **rates** are proxy by Interbank Overnight **interest** **rates**, 3 Months Treasury Bill **rates**, Saving Deposit **Rates** and 3 Months Fixed Deposit **rates** are drawn from the International Financial Statistics, IMF. The inflation **rates** used to generate the **real** **interest** **rates** are calculated by taking log-differences of a quarterly Consumer Price Indices (CPI).

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In this paper we use two simple descriptions of the long run link between **real** **interest** **rates** and inflation, and subsequently test their empirical performance, using similar techniques as employed in P-star modeling. In an empirical study, based on cointegration analysis, we show that the gap between the **real** and natural rate of **interest** does not determine inflation, as it is often postulated, but its growth rate. We find that this relationship describes reasonably well the long run influence of the **interest** rate gap on inflation. Simultaneously we calculate the average natural rate of **interest**.

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The role of **real** **interest** **rates** in saving behavior is more difficult to gauge. One problem--which is particularly important in Africa--is that financial markets remain thin and governments often set **interest** **rates** at nonmarket levels. Nevertheless, there is some evidence that "financial saving increased as a result of the increase in **real** **interest** **rates** associated with liberalization of financial markets in developing countries, both in Africa and elsewhere. For example, increases in saving **rates** have been associated with higher **real** **interest** **rates** in Indonesia and the Republic of Korea and, more recently, in

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The length of the sample is then varied. Impulse responses show that the **real** oil price has responded inversely to innovations in shorter-term U.S. **real** **interest** **rates** since at least 1988. This indicates that the relationship between these variables has not changed substantially over time. The relationship between longer-term U.S. **real** **interest** **rates** and the **real** oil price has changed. The sample must run through at least 2006 for the **real** oil price to fall in response to an innovation in longer-term U.S. **rates**. Variance decomposition also shows that the fraction of the forecast error variance of the **real** oil price accounted for by longer-term U.S. **rates** begins to increase in 1999, and reaches two percent in 2006 when the relationship becomes statistically significant. We also show that the ordering changes the responses, but the results are robust to the frequency of the data, lag length, time trends, filtering, and additional explanatory variables.

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This does not mean that estimating more precisely the natural rate of **interest** would not be helpful for monetary policy. We still do not know much about the behavior of this variable. Its determinants, among others the marginal product of capital, the productivity growth rate and the subjective discount rate of private agents are only hardly observable. With better estimates of the natural rate of **interest**, central banks could influence economic behavior with more precision. Disinflating countries would know, at what level to set **real** **interest** **rates**, after disinflation has been finished, without taking the risk of reflating the economy again.

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The upshot of this section is that at any given level of GNP, there are reasons to expect real inter- est rates to be higher if the money supply is smaller in comparison to demand, if th[r]

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Bacchetta and van Wincoop (2010) build a model based on this intuition. Much of the empirical literature that has documented the phenomenon of delayed overshooting has focused on the response of exchange **rates** to identified monetary policy shocks. 2 But in the original context, the story was meant to apply to any shock that leads to an increase in relative **interest** **rates**. Risk- based explanations of the **interest** parity puzzle have not confronted this literature’s finding that high **interest** rate currencies are strong currencies. Our empirical findings are consistent with Froot and Thaler’s hypothesis of delayed overshooting, but with one important modification. The empirical methods here allow us to uncover what the level of the **real** exchange rate would be if uncovered **interest** parity held, and to compare the actual **real** exchange rate with this notional level. We find the level of the **real** exchange rate is excessively sensitive to **real** **interest** differentials. That is, when a country’s **real** **interest** rate increases, its currency appreciates more than it would under uncovered **interest** parity. Then it continues to appreciate for a number of months, before slowly depreciating back to its long run level.

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As noted above, low and floating **real** **interest** and inflation **rates** have been observed since the Great Recession. Hence, the cause of the Great Recession needs to be examined prior to examining the mechanism of floating **rates**. Harashima (2016a) showed a cause of the Great Recession based on the concept a “Nash equilibrium of a Pareto inefficient path” (NEPIP). The concept of NEPIP reported by Harashima (2004a, 2009, 2012, 2016a, 2016d, 2017, 2018) enables us to explain a mechanism for why households rationally choose a Pareto inefficient path. Because of this choice, phenomena like the Great Recession and the Great Depression can be generated. An important feature of NEPIP is that it does not require a sudden huge technological regression and persisting rigidities in price adjustment processes to explain the Great Recession.

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Despite the difficulties involved in the precise determination of equilibrium **real** **interest** **rates**, it seems clear that nominal **interest** **rates** has been higher in Brazil than in similar emerging economies. This paper aims to shed light on the possible reasons for this feature of the Brazilian economy. We extend Miranda and Muinhos (2003) one-country study to a sample of 20 countries, using many methods to compare measures of the **real** **interest**: (i) extracting equilibrium **interest** **rates** from IS curves; (ii) extracting steady state **interest** **rates** from marginal product of capital; (iii) capturing relevant variables and the fixed effects having **real** **interest** **rates** as dependent variable in a panel for emerging countries; and (iv) extracting inflation expectation from the spread between fixed rate and inflation-indexed treasure notes.

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The IMF article IV consultation 2008 shows that the UAE had negative **real** **interest** **rates** persisted for years. Qatar too had a persistent negative **real** **interest** rate. Oman's rate became negative in 2007-2008. The other GCC countries have very low **real** **interest** **rates**. The GCC produce about 23 percent of the world's oil and controls 40 percent of the world's oil reserve. They probably feel safe from speculators because of their sizable foreign reserves. They also seem content with the fixed exchange rate regime and oblivious to housing price bubbles. The UAE and Qatar are similar to Hong Kong in many aspects.

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On the other hand, however, high **real** **interest** **rates** may reflect favourable external conditions for emerging markets, which reduce the risk of default. For example, **real** **interest** **rates** are usually high when world economic growth is strong and, concurrently, investors’ risk appetite is heightened on average, which makes investment in emerging countries all the more likely. Conversely, in times of world crises, **interest** **rates** are usually lowered to ease pressure on the financial sector.

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This study explores the long-run equilibrium relationship between **real** exchange **rates** of Riels/$US and **real** **interest** differentials in a transition economy, Cambodia. A battery of cointegration tests i.e. Engle-Granger tests, Johansen’s multivariate tests without and with unknown structural break(s), have been used for analysis. The monthly data between November 1994 and August 2009 supports this theoretical relationship between **real** exchange **rates** and **real** **interest** rate differentials (Cambodia’s deposit **rates**). This finding initially enhances fundamental knowledge of the so-called sticky-price model of exchange rate determination in Cambodia, in which the country’s **real** exchange **rates** can be predicted by the variation between domestic **real** **interest** **rates** (**real** deposit **rates**, r D ) and world **real** **interest** **rates** (r * ). By the same

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Despite the difficulties involved in the precise determination of equilibrium **real** **interest** **rates**, it seems clear that nominal **interest** **rates** has been higher in Brazil than in similar emerging economies. This paper aims to shed light on the possible reasons for this feature of the Brazilian economy. We extend Miranda and Muinhos (2003) one-country study to a sample of 20 countries, using many methods to compare measures of the **real** **interest**: (i) extracting equilibrium **interest** **rates** from IS curves; (ii) extracting steady state **interest** **rates** from marginal product of capital; (iii) capturing relevant variables and the fixed effects having **real** **interest** **rates** as dependent variable in a panel for emerging countries; and (iv) extracting inflation expectation from the spread between fixed rate and inflation-indexed treasure notes.

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Chart 6 presents a scatter plot of the world **real** **interest** rate against the realized world rate of investment/ savings. One possible interpretation of Chart 6 is that the net supply of savings had two distinct periods: the first, which one might consider to be before 1979 (highlighted by the savings-supply curve S A S A ), and a subsequent period after 1983 (illustrated by the curve S B S B ). During each of these two periods, it appears that the savings-supply equation was relatively stable, suggesting that variations in investment demand could be the dominant factor driving changes in the world **interest** rate. For example, in the late 1970s, there appears to have been an increase in the level of desired investment (a shift in the investment demand curve, not shown), which caused excess demand in the market, pushing **real** **interest** **rates** up along the savings-supply locus S A S A . Between 1979 and 1983, however, **interest** **rates** seem to have been pushed higher, primarily owing to a reduction in global savings plans, as illustrated by the shift of the savings-supply curve from S A S A to S B S B . In the period between 1983 and 1989, **interest** **rates** stayed high as investment demand remained strong. A final observation to be drawn from Chart 6 is that the low level of **real** **interest** **rates** that had appeared by 2004 seems more likely to be explained by a decade or more of weak investment demand than by an excess supply of savings. Indeed, relative to the early 1970s, when **real** **interest** **rates** were also low, the supply of global savings during and before 2004 appears to have fallen. Chart 6 naturally raises questions as to what caused these three signifi- cant shifts in desired savings and investment. With this in mind, the next section provides a conceptual overview of the key determinants of desired savings and investment.

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not statistically different before or after IV/1969 14 Changes in **real** balances have the same statistical effect on **real** **interest** **rates** across the sample period. Finally, it is appropriate to note that the estimated relationship implies apositive relationship between the volatility in teal money balances and the volatil- ity in **real** **interest** **rates**- If the frequency ofchange in **real** money balances Increases, the estimated rela- tionship implies an increase in the frequency of change in **real** **interest** **rates**. The evidence pre- sented here suggests that more stable **real** money growth, even over periods as short as a quarter, will produce a more stable pattern of **real** **interest** rate movements. 15

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In the case of advanced economies, which are more or less operating on the best attainable efficiency level, the **real** growth rate sets the limit for the **real** **interest** rate in the economy. It is interesting, therefore, to observe that the typical **real** **interest** rate on **government** paper in some of the advanced economies vary from 3 to 4 per cent, which is close to their growth rate of GDP. In the case of developing economies, the typical **real** **interest** **rates** are higher than those of the developed economies which is perhaps due to the higher **rates** of growth in these economies. It is possible that for a fast growing and high performing economy, the **real** rate of **interest** may in fact stay higher than the **real** growth rate, if the potential growth rate is higher than the actual growth rate and if expectation regarding the future growth rate is strong. However, a persistent high **real** **interest** rate which exceeds the **real** growth rate is not sustainable in the long run as this implies that the service cost of the capital stock exceeds the rate of return from capital. The **real** **interest** rate is significantly influenced by the efficiency of the financial system. A well functioning financial market helps reduce the cost of financial intermediation, and thereby brings down the spread between the **interest** rate on savings and that charged on investment. Not only that, even, an unsustainable fiscal policy, with a high burden of public debt, provides a downward stickiness to the **real** **interest** rate.

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Although higher (cyclically adjusted) budget de¯cits appear to be associated with lower long **real** **rates** according to the `trend in°ation' measure (contrary to our expec- tation), de¯cits have no discernible e®ect on short **rates**, nor on the `moving average' long rate measure. The insigni¯cance of the budget de¯cit is consistent with results in Barro and Sala-i-Martin (1990) and Barro (1992). Blanchard (1985) showed that the importance of de¯cits declines, the longer the horizon of households (and disappears when agents have in¯nite horizons). So our results are consistent with the behaviour of in¯nitely-lived agents. When agents are ¯nitely-lived, it is the expected sequence of de¯cits that matters for aggregate demand. In that case, current de¯cits matter only to the extent they proxy, or predict, (a weighted sum of) future de¯cits. Barro (1992) found current de¯cits to be very poor predictors of future de¯cits. Our results therefore should be interpreted as con¯rming that it is not helpful to look at current de¯cits in assessing the impact of ¯scal stance on **real** activity and **interest** **rates** | but this does not necessarily mean that expected future de¯cits do not matter.

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