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The Inverted Leading Indicator Property and Redistribution Effect of the Interest Rate

Patrick Pintus, Yi Wen () and Xiaochuan Xing
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Xiaochuan Xing: Yale University

No 2016-27, Working Papers from Federal Reserve Bank of St. Louis

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 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 Loan Repayment; Redistribution Shocks; Multiple Equilibria. (search for similar items in EconPapers)
JEL-codes: E21 E22 E32 E44 E63 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge and nep-mac
Date: 2016-11-30, Revised 2017-02-22
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DOI: 10.20955/wp.2016.027

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