TAILIEUCHUNG - Is the long-term interest rate a policy victim, a policy variable or a policy lodestar?

Bernanke and Gertler (1989) focus on the investment decision of rms. There is asymmetric information between lenders and entrepreneurs: while entrepreneurs know the pro tability of their investment projects, lenders must pay an auditing cost to observe the project's return. This information asymmetry is the key source of persistence in the model. A positive productivity shock increases savings of entrepreneurs and lowers agency costs, making it easier for them to obtain external nance. As a result, more investment projects are nanced, which creates employment for young agents and leads to further income expansion in subsequent periods. Kiyotaki and Moore (1997) add an additional element to this story: the. | BANK FOR INTERNATIONAL SETTLEMENTS BIS Working Papers No 367 Is the long-term interest rate a policy victim a policy variable Or a policy lodeStar by Philip Turner Monetary and Economic Department December 2011 JEL classification E12 E43 E58 G18 and H63 Keywords Long-term interest rate bond market government debt management financial regulation central banks BIS Working Papers are written by members of the Monetary and Economic Department of the Bank for International Settlements and from time to time by other economists and are published by the Bank. The papers are on subjects of topical interest and are technical in character. The views expressed in them are those of their authors and not necessarily the views of the BIS. This publication is available on the BIS website . Bank for International Settlements 2011. All rights reserved. Brief excerpts may be reproduced or translated provided the source is stated. ISSN 1020-0959 print ISBN 1682-7678 online Is the long-term interest rate a policy victim a policy variable or a policy lodestar Philip Turner 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 .

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