清华大学货币银行学讲义（考研必备）ch5 determination of interest rate

1,Ch5. Determination of interest rate,To understand The role of interest rate in economy (preliminary)The theories of determination of interest rateClassical theory Loanable funds theoryLiquidity preference theory Rational expectation theoryThe elements to influence interest rate,2,5.1 the role of interest rate in economy,Interest rate is the key issues to determine the volume & transformation of saving to investmentAllocated the saving resources & credit resourcesThe key element to influence the equilibrium of money supply and money demandAn important benchmark for value of other financial instruments (bonds, shares, funds)An important macro-economic policy,3,The rate of interest is a payment from borrow to lenders which compensates the latter for parting with funds for a period of time and at some risk. It is rewarding savers for giving-up the ability to consume for a period of time.,5.2 Conceptions of interest rate,Nominal interest rates are the rates of interest that are actually paid in money form. The real interest is the return that lenders require even if there is no risk and prices are constant. This is the pure return for giving up the ability to spend for a period of time. Since the time have value, the long-term real interest rate will be higher than short-term real interest rate.,4,Classical theory of interest rates is an explanation of the level of and changes in interest rates that relies on the interaction of the supply of savings and the demand for investment capital. It also called as real flow of funds theory.,5.3 classical theory of interest rates,5,6,the equilibrium rate of interest in classical theory of interest,7,5.4 Loanable funds theory of interest,Loanable funds theory of interest was Primarily developed by monetary economist Dennid Robertson (1933). Keynesian theory. it think that the demand and supply of “loanable funds” decide real interest rate.,8,5.4.1 The demand of Loanable funds,9,5.4 Loanable funds theory of interest,5.4.2 supply of LFs,10,5.4.3 case study about equilibrium rate,The factors of supply：The saving of household: +,-the critiral of loan of bank:+ -Money supply of central bank + -,5.4 Loanable funds theory of interest,The elements that influence the demand of loanable curveConfidence of consumers Reduce of fiscal deficits Slump of stock market, damage the confidence of firms,Chang of the demand of LFs,Chang of LFs supply,11,5.5 liquidity preference theory of interest rates,5.5.1 demand of liquidityMotives：Transaction precautionary and speculation demandDemand of money：M/p=f(Y, i),5.5.2 equilibrium of interest rate of liquidity theory：money supplymoney demand,Liquidity preference theory of interest rate : an explanation of the level of and change in interest rates that focuses on the interaction of the supply of and demand for money,12,5.5 liquidity preference theory of interest rates,LP theory provides some useful insights into investor behavior and the influence of government policy on the economy and financial system. It illustrates how central banks can influence interest rates in the financial markets in short term.,MS & interest rate: a combined effect in a period,13,Summary of the liquidity preference approach:Agents actions determine nominal interest rates. Real rate will depend upon the behavior of prices and the extent to which price changes are correctly anticipated;The nominal rate is determined by the demand for money relative to its supply;The demand for money depends upon the price level and upon the level of economic activity but it also depends upon the desire to hold money as a safe asset in as uncertain world;The degree of uncertainty that agents feel is highly variable, leading to fluctuations in the demand for money and hence in the nominal rate of interest;The supply of money is independent of the demand for it and is assumed to be fixed by the actions of the monetary authorities.,14,5.5.3 limitations of the liquidity preference theoryOnly concern the demand & supply of the money. Neglected the actions of other sectors or neglected the demand & supply of funds of others sectors. It is a short-term approach to interest rate determination (because it assumes that income remains stale). In the longer term, interest rates are affected by changes of levels of income and by inflationary expectations.,5.5 liquidity preference theory of interest rates,15,Rational expectations theory of interest rates : an explanation of the level of and changes in interest rates based on changes in investor expectations regarding future security prices and returns. This theory builds on research evidence that the money and capital markets are highly efficient institutions in digesting new information affecting interest rates and security prices.,5.6 the rational expectations theory,New information: the key player,Expectation and Action : buy or sell,Equilibrium,16,5.6.1 the assumption of rational expectations theorymarket is perfectly efficient The interest rate and price of securities have reflected all the useful and avaliable informantindividuals are rational agents who form expectations about the distribution of future prices of security and interest rates. Rational agents attempt to make optimal use of the resources. They make unbiased forecasts of future prices, interest rates. No systematic forecasting errors,The change of interest rate and price of securities are only related to the unexpected information. The transaction cost and storage cost of securities can be neglected5.6.2 the equilibrium of interest rateIf all above assumptions can be hold, the equilibrium of interest rate should be exactly the rate of expectation rate, namely:E（r）= rNo systematic forecasting errorsThe passed information has no influence on change of interest rateThe change of interest rate is decided by the change of expectation.,5.6 the rational expectations theory理性预期理论,17,The theory explains some phenomenon about changing of interest rate and prices of the securities that can not be explained by the traditional theories. Some of the assumptions can be hold or accepted Some of testing evidences about the role of expectation Mishkin，Pipperger：the current changing of interest rates do not have clearly relations with the current returns of bonds & other shares. The expectation have already influenced the prices of those securities.Engle & Frankel,(1984) the passed information has almost not influence on the level of interest rate. The unexpected information has clearly correlation with rate of return of bonds & securities， expecially has storng correlation with short-term interest rate.Some criticism:The model about formation of expectation of public can not be conviction.Assumption about the zero transaction cost is no realistic. The information for decision making is so simple that it can not provide foundation to assure that the decision is rationality.,5.7 evaluation of rational expectation theory,18,5.7 Loanable fund theory + rational expectation: a better modification?,The challenge for the monetary policyIf the policymaker can not know the expectation of public about the rate, the policy they made may cause the opposite results Before implementation of the policy, the authorities should anticipate what kinds of new information will be emerging. Maybe the new information which to be relied on deciding the new policy should not be expected by the market.,E0,E1,E2,r,M,S,D,If Modified the LF theory with the rational expectation theory, the rational expectation theory can has its fundamental of analyses, and the LF theory can combine the expectation elements. The demand & supply of loanable funds not only reflects the real demand & supply but also reflect the expected demand & supply. The interest rate is determined by the real demand & supply as well as the expectation about them. Namely:,Modified the limitations of LF & RE theories:,19,many of the factors can influence the demand & supply of loanable funds as well as the expectation about them, and therefore the nominal interest rate: the most important factors including:Expectation about inflationFiscal deficitsThe monetary policy of the central bankEconomic cycle,5.8 factors that influence the interest rate,20,7.8.1 inflation and interest rate,5.8 factors that influence the interest rate,7.8.2 expected inflation & Fisher effects（1896）Fishers effect: The changing of expected inflation will cause the change of nominal interest rateFunction of Fishers effect: i = r + pewhere： i: nominal rate；r: real rate (when infl