Cycles in policy interest rates in advanced economies during the last 54 years
In this paper Forbes et al. examine how interest rate cycles have gradually evolved over time in 54 advanced economies during the period from 1970 to 2024. They look at “the characteristics of easing and tightening phases; how they have changed over time; how economic growth, employment, and inflation have evolved over these cycles; the extent to which rate cycles have been synchronized globally; and the causes of these cycles.” They apply business cycle methodology to identify turning points in rate cycles as well as time-series techniques, employing a factor-augmented vector autoregressive (FAVAR) model, to analyze a set of global and domestic shocks behind these cycles. Their findings include:
1. Rate cycle characteristics:
- Tightening phases lasted an average of 47 months, while easing phases lasted 79 months on average.
- Tightening phases involved fewer and smaller rate changes compared to easing phases.
- The characteristics of rate cycles have changed over time, with tightening phases becoming less aggressive from the 1970s to the 2010s.
2. Synchronization of rate cycles:
- There has been increased synchronization of rate cycles across countries over time.
- The post-pandemic period (2022 onwards) saw the most synchronized tightening since 1970, with all economies except Japan in a tightening phase.
- The paper identifies five “Highly Synchronized Tightening” periods since 1970.
3. Drivers of rate cycles:
- Global factors have become increasingly important in driving rate cycles over time.
- The contribution of global shocks to interest rate variance doubled from 23% in 1970-1998 to 47% in 1999-2023.
- Global demand shocks played the largest role among global factors.
4. Recent tightening phase (2022 onwards):
- It has been more aggressive than tightening phases since 2008, resembling pre-2008 patterns.
- Global factors explained nearly 80% of rate increases during this phase, compared to 35% in other tightening periods.
5. Exiting tightening phases:
- Central banks have been holding rates constant for longer before shifting to a new phase.
- Countries with lower inflation rates tended to cut rates earlier when exiting highly synchronized tightening periods.
6. Implications for policy:
- The paper suggests gradual recalibration of interest rates going forward, considering global factors and domestic circumstances.
- It emphasizes the importance of accurately differentiating between global supply and demand shocks.
Rate Cycles
Authors: Kristin Forbes, Jongrim Ha, M. Ayhan Kose
From: MIT, world Bank
Monetary policy in a changing world
In this report Claudio Borio discusses the lessons learned from the monetary policy cycles during the 21st century. He argues that central banks have faced extraordinary challenges since the 2008 financial crisis, including the Great Financial Crisis, the COVID-19 pandemic, and a surge in inflation and they have responded with unprecedented policy measures.
1. Key lessons learned include:
- Forceful monetary tightening can prevent inflation from becoming entrenched in a high-inflation regime.
- Central banks can effectively stabilize the financial system during crises through balance sheet policies and emergency measures.
- Prolonged monetary easing has limitations, including diminishing returns and potential side effects on financial stability.
- Communication has become more complex due to the use of multiple policy tools.
- Foreign exchange intervention and macroprudential policies can complement monetary policy, especially in emerging markets.
2. Going forward, monetary policy frameworks should focus on:
- Robustness to different scenarios
- Realism in ambition regarding what monetary policy can achieve
- Maintaining safety margins and policy space
- Nimbleness to respond to changing conditions
4. Challenges and policy recommendations:
- Challenges ahead include unsustainable fiscal trajectories and potential structural changes that could make economies more inflation-prone.
- There is need for coherence across different policy domains (monetary, fiscal, prudential) to achieve sustainable macroeconomic and financial stability.
- Central banks should aim to keep inflation within the region of price stability while safeguarding financial stability, rather than fine-tuning inflation or pushing for overly ambitious growth targets.
Monetary policy in the 21st century: lessons learned and challenges ahead
Authors: Claudio Borio
From: BIS
