Abstract: We analyze the determinants and international transmission of interest rates by focusing on the accumulation of international reserves and sovereign debt. We develop a model, which describes the money market equilibrium with capital account openness, which predicts that higher levels of international reserves lead to lower interest rates whereas the effect of higher government debt is ambiguous. We then test empirically these predictions on a panel of 130 countries over the period 1985-2019. We find that: i) the transmission of U.S. interest rates to domestic interest rates is stronger in emerging market economies (EMEs) than in advanced economies (AEs) for short-term interest rates, and vice versa for long-term interest rates; ii) international reserves help counteract the transmission of the U.S. monetary policy on short-term interest rates in EMEs; iii) a higher sovereign debt level is associated with lower interest rates in EMEs (liquidity effect), but higher interest rates in developing economies (risk premium effect); iv) a higher sovereign debt level reduces the influence of U.S. long-term interest rates on domestic long-term interest rates in AEs.

avec António Afonso (ISEG - University of Lisbon, REM and UECE), João Jalles (ISEG - University of Lisbon, REM and UECE), et Piotr Stanek (Cracow University of Economics)