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The interest rate sensitivity of output in Finland

Listed author(s):
  • Takala, Kari
Registered author(s):

    Monetary policy affects the economy through the exchange rate and interest rates.It is assumed that the relationship between interest rates and GDP is negative and that interest rates affect GDP more powerfully than the other way around.These conclusions are confirmed here.Estimated elasticities--which compare annual percentage changes in GDP to annual percentage changes in the interest rate-produce interest rate elasticity close to unity.It should also be stressed that a nominal interest rate effect is found instead of a real rate effect both in GDP and its components. For private consumption, the interest rate measures the relative future price of consumption, which includes substitution and income effects.According to estimations the interest rate elasticity for non-durable consumption is around -0.4, which indicates the dominance of the substitution effect. For durable purchases, the interest rate elasticity is much higher and is also volatile.Rough estimate showed that the interest rate elasticity for durables could be around -4.0. For private investment, the interest rate measures the opportunity cost of investment and a cost factor in debt financing.Financial deregulation has obscured the importance of interest rates in determining manufacturing investment.It seems that during the boom years domestic lending rates lost their significance in affecting investment plans.A rough estimate for a long-term interest rate elasticity of manufacturing investment could be -2.On the other hand financial deregulation has clearly increased the power of interest rates in determining the level of housing investment. During 1980s the real lending rate became a significant determinant of housing investment, and we cannot reject the hypothesis of unitary elasticity, ie. elasticity of -1.

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    File URL: https://helda.helsinki.fi/bof/bitstream/123456789/7617/1/SP_DP_1995_11.pdf
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    Paper provided by Bank of Finland in its series Research Discussion Papers with number 11/1995.

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    Date of creation: 1995
    Handle: RePEc:bof:bofrdp:1995_011
    Contact details of provider: Postal:
    Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland

    Web page: http://www.suomenpankki.fi/en/

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    1. Beverly Hirtle & Jeanette Kelleher, 1990. "Financial market evolution and the interest sensitivity of output," Quarterly Review, Federal Reserve Bank of New York, issue Sum, pages 56-70.
    2. Christopher A. Sims, 1986. "Are forecasting models usable for policy analysis?," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 2-16.
    3. Mullins, Mark & Wadhwani, Sushil B., 1989. "The effect of the stock market on investment: a comparative study," European Economic Review, Elsevier, vol. 33(5), pages 939-956, May.
    4. Kajanoja, Lauri, 1995. "Aggregate investment and corporate indebtedness , Some empirical avidence from Finland," Research Discussion Papers 10/1995, Bank of Finland.
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    7. Chadha, Bankim & Tsiddon, Daniel, 1998. "Inflation, nominal interest rates and the variability of output," Journal of Monetary Economics, Elsevier, vol. 42(3), pages 547-573, October.
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    13. repec:fth:harver:1491 is not listed on IDEAS
    14. Kari Takala & Matti Tuomala, 1990. "Housing investment in Finland," Finnish Economic Papers, Finnish Economic Association, vol. 3(1), pages 41-53, Spring.
    15. Tobin, James, 1969. "A General Equilibrium Approach to Monetary Theory," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 1(1), pages 15-29, February.
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    17. Olivier Blanchard & Changyong Rhee & Lawrence Summers, 1993. "The Stock Market, Profit, and Investment," The Quarterly Journal of Economics, Oxford University Press, vol. 108(1), pages 115-136.
    18. Bernanke, Ben S., 1986. "Alternative explanations of the money-income correlation," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 25(1), pages 49-99, January.
    19. Abel, Andrew B., 1990. "Consumption and investment," Handbook of Monetary Economics,in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 2, chapter 14, pages 725-778 Elsevier.
    20. Hayashi, Fumio, 1982. "Tobin's Marginal q and Average q: A Neoclassical Interpretation," Econometrica, Econometric Society, vol. 50(1), pages 213-224, January.
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