Determinants Of Long-Term Interest Rates In The United States

Abstract

The behavior of the long-term interest rates is a practical problem for private and public organizations. Organizations need to estimate interest rates for purposes of assigning value to long-term obligations such as defined benefit plans and long-term leases and making decisions related to long term capital purchases. The purpose of this study was to analyze the determinants of long-term interest rates in the United INTRODUCTIONconomists and practitioners are interested in how to predict trends long-term interest rates (LTI) and interest rates trends (Wade, 2010). The ability to understand interest rate trends is of interest to policymakers, financial analysts, corporation leaders, and individuals who must make decisions based upon future interest rates (Adrian & Shin, 2009;Blinder, 2010;Wade, 2010). LTI affect key interest-rate sensitive sectors of the U.S. economy, such as housing, auto, and investment; interest rates also affect corporate decisions related to pension and asset valuation (Saher & Herbert, 2010).Especially since the beginning of our current financial crisis starting in 2007, it is clear that interest rates impact the economic recovery. Unfortunately, the lack of accurate information related to future trends of LTI impairs the ability of organizations to accurately plan for the future (Adrian & Shin, 2009). Policymakers, financial analysts, and organizations need to make specific decisions that are based, in part, on future interest rates trends.Understanding determinants of LTI is critical for individuals who make decisions based upon LTI trends. The goal of this study is to increase our understanding of determinants of LTI in the United States by extending prior research by Saher and Herbert (2010) who examine determinants of LTI in Pakistan.We examine the relationship between LTI (30-year U.S. Treasury constant securities rate) and overnight interest rate along with other key macroeconomic variables including GDP, inflation, net capital inflow, and budget deficit for the United States during a period from 1999-2009. We conduct our analysis in three steps: (a) a Johansen co-integration test (Johansen, 1988), (b) time series regression analysis with normalized co-integration coefficients, and finally (c) time series regression analysis with a vector error correction model to test our hypothesis. We find that overnight interest rates, budget deficit, net capital inflow, and inflation positively affect long-term interest rate whereas GDP negatively affects the long-term interest rate. In addition, our results indicate that overnight interest rates, inflation, net capital inflow, budget deficit, and GDP jointly explain, in part, the behavior of long-term interest LTI in the United States. 258 © 2012 The Clute InstituteThis study contributes to the understanding of determinants of LTI. In addition, this study has a direct impact on accounting and finance. Accounting practitioners need to develop models that predict LTI for the financial statements presentation of long-term debt obligatio...