Abstract
The paper uses historical data on interest rates from 1920 to 2016 to explore whether a world rate of interest exists and whether a monetary hegemon affects it. The first principal component of long-term interest rates accounts for 75% of the variation in a matrix of 17 countries and proxies for the world rate of interest. The U.S. played the role of a hegemon, influencing long-term bond rates. After the introduction of the euro in 1999, interest rates in most European countries followed German interest rates but German rates followed U.S. rates even more than before the introduction of the euro. In two countries on the northern periphery, Denmark and Sweden, interest rates shadow German rates and the low rates have contributed to rising house prices and rising mortgage debt. Independent monetary policy calls for targeted controls on capital flows.
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Notes
Jorda et al. (2019). The countries are Australia, Belgium, Canada, Denmark, Finland, France, Germany, Italy, Japan, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, the UK and the U.S.
The choice to use nominal rather than (ex-post) real rates is based on the observation that the ex-post real rates fluctuate significantly due to unexpected inflation shocks.
There are missing observations around WWII in Finland, Germany and Spain that lower the number of years from 97 to 84.
Currency convertibility in Europe occurred only in 1958.
Figure 1 shows the two principal components when three countries that have missing observations for the years around WWII are omitted (Finland, Germany and Spain). This yields continuous series for both PCs. With these countries omitted, the first principal component explains 80% of the variation and the second 9%.
They found that as of 1929, the dollar and sterling accounted for some 97 percent of global foreign exchange reserves.
Serial correlation and heteroskedasticity in the panel may make the conventional standard errors unreliable.
McCauley (1997) found that convergence occurred well before the introduction of the euro in 1999.
Repo stands for repurchase agreement.
Eggertsson et al. (2019) show that the transmission to bank lending rates may break down when policy rates become negative. Others argue that negative rates do provide stimulus to the economy, see, amongst others, Adolfsen and Spange (2020) who describe the transmission of negative repo rates into lending and deposit rates and then to investment and employment. See also Eisenschmidt and Smets (2018) on the effect of negative policy rates in the euro area.
For a contrasting view, see Lilley and Rogoff (2020) for the case for negative policy rates in the post-pandemic world.
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Acknowledgements
Paper presented at the 90th International Atlantic Economic Conference, 15–18 October 2020. The author thanks Robert McCauley and Ron Smith for their comments.
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Zoega, G. Monetary Hegemony and its Implications for Small, Open Economies. Atl Econ J 48, 431–446 (2020). https://doi.org/10.1007/s11293-020-09694-y
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DOI: https://doi.org/10.1007/s11293-020-09694-y