Both countries have their own currencies, similar GDP growth and low inflation. Yet Sweden has 0% central bank interest rates while Iceland has 5%.
Can someone explain?
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$\begingroup$ What leads you to think that they would have the same interest rates? $\endgroup$ – 410 gone Nov 14 '16 at 12:21
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$\begingroup$ Both with their own currency, similar GDP growth, similar GDP (per person), similar inflation. $\endgroup$ – Karlth Nov 14 '16 at 17:17
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1$\begingroup$ That doesn't mean their economies are equal though of course. Maybe different investments are needed in each economy, or there's different risks in each country's markets. There are a lot of factors affecting an economy besides GDP and inflation. $\endgroup$ – Kitsune Cavalry♦ Nov 14 '16 at 19:49
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$\begingroup$ What are the interest rates you are speaking about ? Central bank, Treasury bonds,... ? $\endgroup$ – Yann Nov 21 '16 at 16:49
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$\begingroup$ @YM'fr Central bank. $\endgroup$ – Karlth Nov 21 '16 at 20:32
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Here are some elements:
- Considering the two countries independently (like a closed economy), it depends on the real interest rate in the domestic country. If the inflation is zero in both countries, the real interest interest is probably higher in Iceland than in Sweden. To go deeper on this path, look at the Taylor rule which is a good proxy for the monetary policy followed in practice.
- In an open economy, it depends also on the "confidence" foreign agents have in your currency. If they are afraid of a future inflation (so their returns will shrink) they "ask" for a better remuneration. For example the ECB had for years higher interest rate than the FED, and some argued the lack of confidence in the euro was one motive. The interest rate parity is the key word for deeper research.
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$\begingroup$ IMHO, OP question is a bad correlation-causation question. $\endgroup$ – mootmoot Nov 22 '16 at 9:41
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$\begingroup$ Maybe naively formulated... but in his question he gave all variables of the Taylor rules except the real interest rate. Not saying that the Taylor rule is a rule of thumb. $\endgroup$ – Yann Nov 22 '16 at 10:29
