The inverted leading indicator property and redistribution effect of the interest rate

Patrick Pintus, Yi Wen and Xiaochuan Xing

European Economic Review, 2022, vol. 148, issue C

Abstract: The interest rate at which US firms borrow funds has two features: (i) it moves in a countercyclical fashion and (ii) it is an inverted leading indicator of real economic activity: low interest rates today forecast future booms in GDP, consumption, investment, and employment. We show that a Kiyotaki–Moore model accounts for both properties when interest-rate movements are driven, in a significant way, by self-fulfilling belief shocks that redistribute income away from lenders and to borrowers during booms. The credit-based nature of such self-fulfilling equilibria is shown to be essential: the dynamic correlation between current loanable funds rate and future aggregate economic activity depends critically on the property that the interest rate is state-contingent. Bayesian estimation of our benchmark DSGE model on US data shows that the model driven by redistribution shocks results in a better fit to the data than both standard RBC models and Kiyotaki–Moore type models with unique equilibrium.

Keywords: Endogenous collateral constraints; State-contingent interest rate; Redistribution shocks; Multiple equilibria (search for similar items in EconPapers)
JEL-codes: E21 E22 E32 E44 E63 (search for similar items in EconPapers)
Date: 2022
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Related works:
Working Paper: The inverted leading indicator property and redistribution effect of the interest rate (2022)
Working Paper: The Inverted Leading Indicator Property and Redistribution Effect of the Interest Rate (2022)
Working Paper: The Inverted Leading Indicator Property and Redistribution Effect of the Interest Rate (2016)
Working Paper: The Inverted Leading Indicator Property and Redistribution Effect of the Interest Rate (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:eecrev:v:148:y:2022:i:c:s0014292122001283

DOI: 10.1016/j.euroecorev.2022.104219

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