An Analysis of UK Swap Yields

John Maynard Keynes argued that the central bank influences the long-term interest rate through the effect of its policy rate on the short-term interest rate. However, Keynes's claim was confined to the behavior of the long-term government bond yield. This paper investigates whether Keynes's claim holds for the yields of spread products and over-the-counter financial derivatives by econometrically modeling the dynamics of the pound sterling-denominated long-term interest rate swap yield. It uses the generalized autoregressive conditional heteroskedasticity (GARCH) modeling approach to examine the relationship between the month-over-month changes in the short-term swap yield and the month-over-month change in the long-term swap yield, while controlling for several key macroeconomic and financial variables. The month-over-month change in the short-term interest rate has a positive and statistically significant effect on the month-over-month change in the long-term swap yield. This finding reinforces Keynes's conjecture concerning the central bank's influence over the long-term interest rate. The investigation's empirical findings and their policy implications are discussed from a Keynesian perspective.