For central banks, measuring the equilibrium interest rate
-- an abstract concept that cannot be observed -- is a formidable challenge.
Recall that the equilibrium interest rate
for foreign currency loans can be written as:
Competitive equilibrium consists of initial investments s and x, value functions V(s, x; [theta]), a date-1 price p for the long-term asset, and a gross interest rate R in the hidden retrade market such that (i) given p and R, value functions solve (36); (ii) given V, investment choices s and x solve (35); and (iii) the date-1 market for the long-term asset clears, E[n([theta]; s, x, p)] = 0, and R is an equilibrium interest rate
on the hidden retrade market.
d] = y, which implies an equilibrium interest rate
(8) as follows:
In this setting, the equilibrium interest rate
is determined by supply of and demand for investment funds.
In equilibrium, replacing equation 9 back into equation 7 yields the equilibrium interest rate
(for the case with inventories; that is, when max ([I.
The equilibrium interest rate
in our model is determined by the height of the demand curve at the level of reserve balances supplied by the Federal Reserve.
As the equilibrium interest rate
rises, the final-good producers have less (more) incentive to bring forward (postpone) hiring because future hiring becomes less expensive relative to current hiring (the interest rate effect).
Third, comparative-static analysis is applied to determine the potential impact of a change in the exchange rate or the world interest rate on the equilibrium interest rate
For our purposes, it suffices to acknowledge that these bounds make the dependence between the equilibrium interest rate
and the present value of the public good ambiguous.
In simulating the model, we first determine the equilibrium interest rate
from equation (10).
The example has three behavioral equations - two equations describe the policy rules of the FOMC and of the discount window, and the third characterizes the reduced-form relationship between the equilibrium interest rate
and the fundamental shocks - and one definitional equation relating TR, BR, and NBR.