Working Paper: CEPR ID: DP941
Authors: Lars E. O. Svensson
Abstract: In the new situation with flexible exchange rates, monetary policy in Europe will have to rely more on indicators than previously under fixed rates. One of the potential indicators, the forward interest rate curve, can be used to indicate market expectations of the time-paths of future short interest rates, monetary policy, inflation rates and currency depreciation rates. The forward rate curve separates market expectations for the short, medium and long term more easily than the standard yield curve. Monetary policy in Germany, France, Sweden, the United Kingdom and the United States is interpreted with the help of forward rates.
Keywords: monetary policy; indicators; term structure of interest rates; exchange rate policy
JEL Codes: E52; F31; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Forward interest rates (E43) | Market expectations of future short interest rates (E43) |
| Forward interest rates (E43) | Market expectations of future inflation rates (E31) |
| Forward interest rates (E43) | Market expectations of future currency depreciation rates (F31) |
| Forward rate curve (E43) | Clearer separation of market expectations over short, medium, and long terms (E32) |
| Monetary policy measures (E52) | Long and variable lags (C32) |
| Floating of the British pound and Swedish krona (F31) | Significant increase in long forward rates (E43) |
| U.S. monetary expansion and low short-term interest rates (E49) | Decrease in long forward rates (E43) |
| Different inflation expectation trajectories (E31) | Reflect credibility of low-inflation monetary policies (E52) |
| Higher credibility of low-inflation monetary policies in Germany, France, and U.S. (E52) | Comparison to U.K. and Sweden (P17) |