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Federal Reserve Bank of St. Louis
Working Papers
The Inverted Leading Indicator Property and Redistribution Effect of the Interest Rate
Patrick A. Pintus
Yi Wen
Xiaochuan Xing
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.


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Patrick A. Pintus & Yi Wen & Xiaochuan Xing, The Inverted Leading Indicator Property and Redistribution Effect of the Interest Rate, Federal Reserve Bank of St. Louis, Working Papers 2016-27, 30 Nov 2016, revised 22 Feb 2017.
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Subject headings:
Keywords: Endogenous Collateral Constraints; State-Contingent Loan Repayment; Redistribution Shocks; Multiple Equilibria.
DOI: 10.20955/wp.2016.027
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