Determinants of long-term interest rates in the Czech Republic

The paper analyses the factors leading to the fall of long-term interest rates in the Czech Republic - respectively, the long-term interest rate differential in the Czech Republic and the Eurozone - between 1998 and 2003. The selection of factors is determined by the Fisher equation, UIP, PPP, expectation hypothesis and neoclassical growth theory. The paper suggests that falling long-term interest rates may have been affected by an expectation of lower short-term rates due to falling inflation expectations and inflation premiums. The decrease of CZK/EUR long-term rate differentials from 4% to 0 can approximately be explained by the one-third decrease of inflation expectations in the. Czech Republic and by the 50% decrease of the relative inflation premium. In the long term, the effect of Czech National Bank monetary policy is dwindling vis-a-vis European Central Bank policy, i.e., euro interest rates. Another factor is the anticipated entry of the Czech Republic into the Economic Monetary Union. The real interest-rate differential has no effect.