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Benign neglect of the long-term interest rate

  • Philip Turner

Large-scale central bank purchases of government bonds have made the long-term interest rate key in the monetary policy debate. How central banks react to bond market movements has varied greatly from one episode to another. Driving the term premium in long-term rates negative may stimulate aggregate demand. And a negative term premium encourages borrowers to lengthen the maturity of their debts. Such a reduction in maturity risks makes the financial system more resilient to shocks, and in particular can help emerging economies finance their heavy infrastructure and housing investment needs more safely. But an extended period of very low long rates and high public debt creates financial stability risks. Interest rate risk in the banking system has grown, and some institutional investors face significant exposures. Central banks in the advanced economies now hold a high proportion of bonds issued by their governments, most of which have so far failed to arrest the rise in the ratio of government debt to GDP. Implementing an effective exit strategy will be difficult. Current policy frameworks should be reconsidered, with a view to clarifying the importance of the long-term interest rate for monetary policy, for financial stability and for government debt management.

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Paper provided by Bank for International Settlements in its series BIS Working Papers with number 403.

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Length: 51 pages
Date of creation: Feb 2013
Date of revision:
Handle: RePEc:bis:biswps:403
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  1. Ken Miyajima & Madhusudan Mohanty & Tracy Chan, 2012. "Emerging market local currency bonds: diversification and stability," BIS Working Papers 391, Bank for International Settlements.
  2. Carol Bertaut & Laurie Pounder DeMarco & Steve Kamin & Ralph Tryon, 2011. "ABS Inflows to the United States and the Global Financial Crisis," NBER Chapters, in: Global Financial Crisis National Bureau of Economic Research, Inc.
  3. William A Allen, 2012. "Government debt management and monetary policy in Britain since 1919," BIS Papers chapters, in: Bank for International Settlements (ed.), Threat of fiscal dominance?, volume 65, pages 15-50 Bank for International Settlements.
  4. Anna Shabunina & Julio Escolano & Jaejoon Woo, 2011. "The Puzzle of Persistently Negative Interest Rate-Growth Differentials: Financial Repression or Income Catch-Up?," IMF Working Papers 11/260, International Monetary Fund.
  5. Hans J Blommestein & Philip Turner, 2012. "Interactions between sovereign debt management and monetary policy under fiscal dominance and financial instability," BIS Papers chapters, in: Bank for International Settlements (ed.), Threat of fiscal dominance?, volume 65, pages 213-237 Bank for International Settlements.
  6. Mariano Kulish, 2005. "Should Monetary Policy use Long-term Rates?," Boston College Working Papers in Economics 635, Boston College Department of Economics.
  7. Joseph E. Gagnon, 2009. "The World Needs Further Monetary Ease, Not an Early Exit," Policy Briefs PB09-22, Peterson Institute for International Economics.
  8. Holmström, Bengt, 2013. "Inside and Outside Liquidity," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262518536, June.
  9. Jagjit S. Chadha & Charles Nolan, 2004. "Interest Rate Bounds and Fiscal Policy," CDMA Working Paper Series 200401, Centre for Dynamic Macroeconomic Analysis.
  10. Stephen Cecchetti & Madhusudan Mohanty & Fabrizio Zampolli, 2010. "The future of public debt: prospects and implications," BIS Working Papers 300, Bank for International Settlements.
  11. Torsten Ehlers, 2012. "The effectiveness of the Federal Reserve's Maturity Extension Program - Operation Twist 2: the portfolio rebalancing channel and public debt management," BIS Papers chapters, in: Bank for International Settlements (ed.), Threat of fiscal dominance?, volume 65, pages 245-255 Bank for International Settlements.
  12. Andrew Filardo & James Yetman, 2012. "The expansion of central bank balance sheets in emerging Asia: what are the risks?," BIS Quarterly Review, Bank for International Settlements, June.
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