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Interest Rates, Risk, and Imperfect Markets: Puzzles and Policies

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  • Stiglitz, Joseph E

Abstract

Traditional theory emphasizes the key role that monetary policy can play through the manipulation of interest rates. But there are several puzzles that cannot be reconciled with standard models. These include: the apparent constancy in interest rates over extended periods, and changes at other times which appear unrelated to changes in technology and demography; the cyclical pattern of movements in real interest rates; the impact of nominal not real interest-rate changes on real variables; and the cyclical pattern of movements in interest-rate spreads. This paper reaches beyond the standard competitive equilibrium, perfect information, model of credit markets towards imperfect information models, particularly those that focus on the determinants of bank behaviour. Of the standard models, the money demand model is most deficient in understanding these puzzles. The loanable funds theory and a generalized version of real productivity theory can be reconciled with imperfect information, and markets and the consequent credit and equity rationing regimes help to explain the puzzles. Specifically, banks may be insensitive to changes in monetary stance owing to risk aversion. There are strong policy implications; it is argued, for instance, that in East Asia raising interest rates exacerbated economic decline and, rather than contributing to exchange-rate stability, may have induced capital flight as default risk increased, lowering risk-adjusted expected returns. Copyright 1999 by Oxford University Press.

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Bibliographic Info

Article provided by Oxford University Press in its journal Oxford Review of Economic Policy.

Volume (Year): 15 (1999)
Issue (Month): 2 (Summer)
Pages: 59-76

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Handle: RePEc:oup:oxford:v:15:y:1999:i:2:p:59-76

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Web page: http://oxrep.oupjournals.org/

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Cited by:
  1. Shiu-Sheng Chen, 2003. "Revisiting the Interest Rate-Exchange Rate Nexus: A Markov Switching Approach," International Finance 0303002, EconWPA, revised 13 Mar 2003.
  2. Demetriades, Panicos O. & Andrianova, Svetlana, 2005. "Sources and Effectiveness of Financial Development: What We Know and What We Need to Know," Working Paper Series RP2005/76, World Institute for Development Economic Research (UNU-WIDER).
  3. Kuper, Gerard H. & Lestano, 2007. "Dynamic conditional correlation analysis of financial market interdependence: An application to Thailand and Indonesia," Journal of Asian Economics, Elsevier, vol. 18(4), pages 670-684, August.
  4. Ferreira, Alex Luiz & Leon-Ledesma, Miguel A., 2007. "Does the real interest parity hypothesis hold? Evidence for developed and emerging markets," Journal of International Money and Finance, Elsevier, vol. 26(3), pages 364-382, April.
  5. Guglielmo Maria Caporale & Andrea Cipollini & Panicos Demetriades, 2003. "Monetary Policy and the Exchange Rate During the Asian Crisis: Identification Through Heteroscedasticity," CEIS Research Paper 23, Tor Vergata University, CEIS.
  6. Ahmad Zubaidi Baharumshah & Venus Khim-Sen Liew & Ron Mittelhammer, 2010. "Non-linearities in Real Interest Rate Parity: Evidence from OECD and Asian Developing Economies," Global Economic Review, Taylor & Francis Journals, vol. 39(4), pages 351-364.
  7. Stracca, Livio, 2005. "Liquidity and real equilibrium interest rates: a framework of analysis," Working Paper Series 0542, European Central Bank.
  8. Bettina Becker & Stephan G Hall, 2005. "Non-Linear Properties of Currency Crises in Emerging Markets," Money Macro and Finance (MMF) Research Group Conference 2005 13, Money Macro and Finance Research Group.

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