Interest rates: Economic and financial relationsihps in theory and practice

EXECUTIVE SUMMARY This study fundamentally addresses three areas: 1.    Interest Rates and Financial Markets. 2.    Interest Rates and the Economy. 3.    Interest Rates and Equity Markets. The early part of the study demonstrates interest rates in the domestic money markets and capital markets to be highly correlated despite differences in risk and maturity structure. International financial market comparisons, reveal Australian interest rates to be significantly correlated by developments in some markets while quite disparate with others. All markets however, exhibit similar behaviour intra-nationally. Unequivocally, the most prominent findings of this research emerge in analyses of the influences of interest rates on the economy and key economic indicators. Disconcertingly, the results of empirical analysis lend little support to relationships expected from economic theory - even allowing for significant lag influences. As such, in many ways: The real result emerging from this study was not so much what it found, - but all the things it did not find: Theory and Practice often differ” Finally the study reviews equity markets where again, little support is found for relationships with interest rates predicted by theory, when contrasted with empirical results. Contrasting foreign and domestic equity markets, the singular dominant feature is the increasing market efficiency which was also notable in earlier analyses of financial markets.