Changes in the Relationship Between the Long-Term Interest Rate and its Determinants
IMF Working Papers, October 1, 1994
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- Changes in the Relationship Between the Long-Term Interest Rate and its Determinants
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Bibliographic details
- Authors: William Lee, Eswar S Prasad
- Published: October 1, 1994
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451854657.001
Summary
- This paper assesses the relative importance of alternative explanations for the rise in long-term interest rates in the United States from October 1993 to April 1994.
- Standard econometric models of the term structure are shown to have a structural break in the early 1980s.
- An important reason for this change in the traditional term structure relationship appears to be an increase in the responsiveness of long-term rates to changes in the stance of monetary policy.
- Augmented term structure models that explicitly incorporate the role of monetary policy in determining the level of long-term rates are constructed; these models track variations in the long-term rate better than traditional term structure models, but still leave a significant fraction of the recent increase in long-term rates unexplained.
Key findings
- Structural break: Traditional term structure relationships exhibit a structural break in the early 1980s.
- Monetary policy responsiveness: There is an increased responsiveness of long-term rates to changes in the stance of monetary policy.
- Model performance:
- Augmented term structure models that include monetary policy effects perform better than traditional models in tracking long-term rate variations.
- Even with augmentation, a significant fraction of the recent increase in long-term rates (October 1993 to April 1994) remains unexplained.
Subject coverage and keywords
- Subject: Financial services; Long term interest rates; Monetary policy; Monetary stance; Monetary tightening; Short term interest rates; Yield curve
- Keywords: augmented equation; coefficient; equation; federal funds rate; interest rate; Long term interest rates; long-term rate; monetary policy coefficient; monetary policy index; Monetary stance; Monetary tightening; rate; Short term interest rates; short-term rate; term structure equation; WP; Yield curve