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The Risk Premium, Interest Rate Determination, and Monetary Independence Under a Fixed, but Adjustable, Exchange Rate
Author(s) -
Pasula Kit
Publication year - 2016
Publication title -
international journal of finance and economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.505
H-Index - 39
eISSN - 1099-1158
pISSN - 1076-9307
DOI - 10.1002/ijfe.1548
Subject(s) - economics , trilemma , monetary policy , risk premium , interest rate , independence (probability theory) , exchange rate , monetary economics , econometrics , offset (computer science) , fixed interest rate loan , covered interest arbitrage , forward rate , international fisher effect , interest rate parity , nominal interest rate , real interest rate , mathematics , statistics , computer science , programming language
This paper examines interest rate determination and monetary independence in a small economy with a fixed exchange rate. The risk premium is determined endogenously in the stochastic, general‐equilibrium model. The sign of the risk premium and the magnitude of the interest rate depend on the specification of the policy rule for the future exchange rate. Increases in domestic credit can decrease, increase or have no effect on the interest rate. The offset coefficient can differ from −1 (the ‘trilemma’ may not hold), but numerical calculations indicate that the offset is close to −1. Under certain conditions, empirical analyses overestimate monetary independence. Copyright © 2016 John Wiley & Sons, Ltd.