Is the Long-Term Interest Rate a Policy Victim, a Policy Variable or a Policy Lodestar?

39 Pages Posted: 23 Dec 2011  

Philip Turner

Bank for International Settlements (BIS) - Monetary and Economic Department

Date Written: December 1, 2011

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.

Keywords: long-term interest rate, bond market, government debt management, financial regulation, central banks

JEL Classification: E12, E43, E58, G18, H63

Suggested Citation

Turner, Philip, Is the Long-Term Interest Rate a Policy Victim, a Policy Variable or a Policy Lodestar? (December 1, 2011). BIS Working Paper No. 367. Available at SSRN: https://ssrn.com/abstract=1976179

Philip Turner (Contact Author)

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

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