Benign Neglect of the Long-Term Interest Rate

51 Pages Posted: 12 Apr 2013

See all articles by Philip Turner

Philip Turner

University of Basel; National Institute for Economic and Social Research, London

Date Written: February 2013

Abstract

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.

Keywords: Central banks, bond market crisis, exit strategy, sovereign debt management

JEL Classification: E43, E52, E58, H63

Suggested Citation

Turner, Philip, Benign Neglect of the Long-Term Interest Rate (February 2013). BIS Working Paper No. 403, Available at SSRN: https://ssrn.com/abstract=2247907

Philip Turner (Contact Author)

University of Basel ( email )

Petersplatz 1
CH-4001 Basel
Switzerland

National Institute for Economic and Social Research, London ( email )

2 Dean Trench St
London, SW1P 3HE
United Kingdom

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