Trilemma or Dilemma: Inspecting the Heterogeneous Response of Local Currency Interest Rates to Foreign Rates

March 23, 2016

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Format: Chicago

Luca A Ricci, and Wei Shi. Trilemma or Dilemma: Inspecting the Heterogeneous Response of Local Currency Interest Rates to Foreign Rates, (USA: International Monetary Fund, 2016) accessed December 26, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

This paper studies the heterogeneous response across countries of local currency interest rates to foreign and domestic factors, thus contributing to the discussion on the policy trilemma in international economics. On average, floaters appear to be less affected by the U.S. in the short run (up to about one year). However, there is large cross-country heterogeneity in the response: floaters that care less about domestic objectives, exhibit stronger fear of floating, or show higher co-cyclicality with the U.S., respond more to foreign rates. This suggests that floating does not necessarily imply a lack of response of local policy rates to foreign ones, but seems to allow independence when needed. Moreover, the effect of foreign rates on the short end of the local interest rate curve seems to operate mainly via the foreign influence on local policy rates, thus suggesting that central banks may be themselves the source of conduit of the “global credit cycle” discussed by Rey (2014). At the same time, most countries face the equivalent of a “Greenspan conundrum” as their long term rates are mainly influenced by foreign factors.

Subject: Balance of payments, Capital controls, Central bank policy rate, Exchange rate arrangements, Financial institutions, Financial services, Foreign exchange, Sovereign bonds, Yield curve

Keywords: Capital controls, Central bank policy rate, Dilemma-trilemma policy debate, Exchange rate arrangements, Global, Interest rates, International financial market spillovers, Local policy rate, Monetary policy, Policy choice, Policy rate, Rate, Rate coefficient, Rate curve, Rate pass-through, Rate regression, Sovereign bonds, Trilemma, WP, Yield curve

Publication Details

Pages:

39
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2016/075
Stock No:

WPIEA2016075
ISBN:

9781475522921
ISSN:

1018-5941

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