RDP 9208: Credit Supply and Demand and the Australian Economy Appendix B: The Loan Rate and Instrumental Variables

Three interest rate variables are treated as being simultaneously determined with the observed quantity of credit: the loan rate itself, the spread between the loan rate and the certificate of deposit rate, and the spread between the loan rate and the weighted cost of funds.

The instruments applied to each of these variables is as follows.

The loan rate:

• lags of the loan rate;
• expected inflation;
• the 90 day bank bill rate;
• the previous period's non farm GDP;
• the spread between the mortgage rate and the thirteen week Treasury note rate;
• the previous period's broad money;
• the rediscount rate for Treasury notes;
• the current and lagged issue yield on thirteen week Treasury notes;
• all banks' capital;
• a time trend.

The spread between the loan rate and other interest rates:

• the maximum rate on certificates of deposit;
• the rediscount rate for Treasury notes;
• the spread between the mortgage rate and the thirteen week Treasury note rate;
• the previous period's broad money;
• the previous period's issue yield on thirteen week Treasury notes;
• the previous period's loan rate;
• all banks' capital;
• the monthly change in non farm GDP.

Instrumental variables were also applied to the earnings price ratio. The instruments were:

• the maximum rate on certificates of deposit;
• the rediscount rate for Treasury notes;
• the spread between the mortgage rate and the thirteen week Treasury note rate;
• the previous period's broad money;
• the previous period's issue yield on thirteen week Treasury notes;
• the previous period's loan rate;
• all banks' capital;
• the monthly change in non farm GDP;
• corporate net worth.