Working Paper: CEPR ID: DP15766
Authors: Matthijs Breugem; Adrian Buss; Jol Peress
Abstract: We propose a novel theory and provide supporting empirical evidence that lower long-term interest rates (e.g., because of ``quantitative easing'') harm informational and allocative efficiency. We develop a noisy rational expectations equilibrium model with an endogenous interest rate that investors use to update their beliefs about economic fundamentals. The interest rate reveals information about discount rates, allowing investors to extract more information about cashflows from stock prices. The precision of the interest-rate signal and, hence, stock-price informativeness increase in the interest rate. As a result, informational and allocative efficiency rise with bond and money supplies and with policy transparency.
Keywords: endogenous interest rates; informational efficiency; capital allocation efficiency; rational expectations; unconventional monetary policy
JEL Codes: E43; E44; G11; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| lower long-term interest rates (E43) | harm informational and allocative efficiency (D61) |
| endogenous interest rate (E43) | signal about noise traders' demand (G40) |
| signal about noise traders' demand (G40) | investors infer precise information about fundamental value of stocks (G14) |
| interest rate (E43) | precision of stock price signal (G17) |
| precision of stock price signal (G17) | greater informational efficiency (D83) |
| bond supply variations (E43) | price informativeness (G14) |
| bond supply variations (E43) | allocative efficiency (D61) |