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Is the long-term interest rate a policy victim, a policy variable or a policy lodestar?

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  • Philip Turner

Abstract

Few financial variables are more fundamental than the "risk free" real long-term interest rate because it prices the terms of exchange over time. During the past 15 years, it has dropped from a range of 4 to 5% to a range of 0 to 2%. By late 2011, cyclical factors had driven it close to zero. This paper explores why. Possible persistent factors are: the investment of the large savings generated by developing Asia in highly-rated bonds; accounting and valuation rules for institutional investment; and financial sector regulation. The consequences could be far-reaching: cheaper leverage; less pressure to correct fiscal deficits; larger interest rate exposures in the financial industry; and a more cyclical bond market. During the financial crisis, central banks in the advanced countries have made the long-term interest rate a policy variable as Keynes had always advocated. This policy focus will draw more attention to the macroeconomic and financial consequences of government debt management policies. Coordination between central bank balance sheet policies and government debt management is essential. With government debt very high for years to come, bond market volatility could confront central banks with unenviable choices.

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Bibliographic Info

Paper provided by Bank for International Settlements in its series BIS Working Papers with number 367.

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Length: 39 pages
Date of creation: Dec 2011
Date of revision:
Handle: RePEc:bis:biswps:367

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Keywords: Long-term interest rate; bond market; government debt management; financial regulation; central banks;

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  1. Jagjit S. Chadha & Sean Holly, 2011. "New Instruments of Monetary Policy," Studies in Economics 1109, Department of Economics, University of Kent.
  2. Eric T. Swanson, 2011. "Let’s twist again: a high-frequency event-study analysis of operation twist and its implications for QE2," Working Paper Series 2011-08, Federal Reserve Bank of San Francisco.
  3. Carmen M. Reinhart & M. Belen Sbrancia, 2011. "The Liquidation of Government Debt," NBER Working Papers 16893, National Bureau of Economic Research, Inc.
  4. Eric M. Leeper & Todd B. Walker, 2011. "Perceptions and misperceptions of fiscal inflation," BIS Working Papers 364, Bank for International Settlements.
  5. Alessandro Missale, 2012. "Sovereign debt management and fiscal vulnerabilities," BIS Papers chapters, in: Bank for International Settlements (ed.), Threat of fiscal dominance?, volume 65, pages 157-176 Bank for International Settlements.
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Cited by:
  1. Ronny Mazzocchi, 2013. "Investment-Saving Imbalances with Endogenous Capital Stock," DEM Discussion Papers 2013/14, Department of Economics and Management.

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