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Did capital market convergence lower the effectiveness of the interest rate as a monetary policy tool?

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  • Jansen, Pieter W.

    (Vrije Universiteit Amsterdam, Faculteit der Economische Wetenschappen en Econometrie (Free University Amsterdam, Faculty of Economics Sciences, Business Administration and Economitrics)

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    Abstract

    International capital market convergence reduces the ability for monetary authorities to set domestic monetary conditions. Traditionally, monetary policy transmission is channelled through the short-term interest rate. Savings and investment decisions are effected through the response of the bond yield to changes in the short-term interest rate. We find that capital market integration increased correlation between long-term interest rates across countries. Short-term interest rates also show more integration across countries and the correlation with the international business cycle has increased. A stronger linkage between international economic conditions and bond yields has important implications for the effectiveness of monetary policy. Monetary policy makers, especially in small countries, will face more difficulties in influencing domestic conditions in the bond market when they apply the traditional monetary policy framework in case of a country specific shock.

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    Bibliographic Info

    Paper provided by VU University Amsterdam, Faculty of Economics, Business Administration and Econometrics in its series Serie Research Memoranda with number 0010.

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    Date of creation: 2006
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    Handle: RePEc:dgr:vuarem:2006-10

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    Related research

    Keywords: Monetary policy; Term structure of interest rates; International capital market convergence;

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    1. Hans Christiansen & Charles Pigott, 1997. "Long-Term Interest Rates in Globalised Markets," OECD Economics Department Working Papers 175, OECD Publishing.
    2. Feldstein, Martin & Horioka, Charles, 1980. "Domestic Saving and International Capital Flows," Economic Journal, Royal Economic Society, vol. 90(358), pages 314-29, June.
    3. Christian Pierdzioch, 2003. "Home-Product Bias, Capital Mobility, and the Effects of Monetary Policy Shocks in Open Economies," Kiel Working Papers 1141, Kiel Institute for the World Economy.
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    5. Butter, Frank A.G. den & Jansen, Pieter W., 2001. "An empirical analysis of the German long-term interest rate," Serie Research Memoranda 0029, VU University Amsterdam, Faculty of Economics, Business Administration and Econometrics.
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    7. Bruneau, Catherine & Jondeau, Eric, 1999. " Long-Run Causality, with an Application to International Links between Long-Term Interest Rates," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 61(4), pages 545-68, November.
    8. M.M.G. Fase & P.J.G. Vlaar, 1997. "International convergence of capital market interest rates," WO Research Memoranda (discontinued) 519, Netherlands Central Bank, Research Department.
    9. Jorg Kramer, 1998. "Determinants of the expected real long-term interest rates in the G7-countries," Applied Economics, Taylor & Francis Journals, vol. 30(2), pages 279-285, February.
    10. Fell, J.P.C., 1996. "The Role of Short Rates and Foreign Long Rates in the Determination of Long-Term Interest Rates," Papers 4, European Monetary Institute.
    11. Hardouvelis, Gikas A., 1994. "The term structure spread and future changes in long and short rates in the G7 countries: Is there a puzzle?," Journal of Monetary Economics, Elsevier, vol. 33(2), pages 255-283, April.
    12. H. Sonmez Atesoglu, 2005. "Monetary policy and long-term interest rates," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 27(3), pages 533-539, April.
    13. Shiller, Robert J. & Huston McCulloch, J., 1990. "The term structure of interest rates," Handbook of Monetary Economics, in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 1, chapter 13, pages 627-722 Elsevier.
    14. repec:nbr:nberwo:2341 is not listed on IDEAS
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