SUBSTITUTION EFFECTS ACROSS
SAVING INSTRUMENTS IN A LOW
INTEREST RATE ENVIRONMENT:
THE CASE OF TRINIDAD AND TOBAGO
By
Dave Seerattan and Julia Jhinkoo
Caribbean Centre for Money and Finance
The University of the West Indies
St. Augustine Campus, Trinidad
Overview

Motivation of Study

Literature Review

Preliminary Findings : Trinidad and Tobago

Further work to be done
Motivation of Study

The depressed demand conditions of most world economies in
the last four years have created a situation where the financial
sectors have been characterised by low interest rates by
historical standards.
AVG = 7.6%
AVG = 3.0%
Motivation of Study
Persistent low interest rates lower lending
standards in the medium term and erode the
value of savings leading to substitution effects
away from relatively safe instruments to more
exotic and risky investments in the search for
higher yields.
 This paper seeks to examine the extent of this
phenomenon and the possible consequence for
risk management and financial supervision in
Trinidad and Tobago.

Literature Review
Studies that have examined the substitution effects across
saving instruments when interest rates are low are limited.

Substitution of Savings Deposits for other Financial
Assets
◦
◦
◦
◦
◦

Alhadeff and Alhadeff (1958)
Hamburger (1968)
Sa et al (2011)
Mayer and Hubbanrd ( 2007)
Laibson and Mollerstrom ( 2009)
Impact of Low Interest Rates :
◦
◦
◦
◦
Cato and Mackenzie (2006)
Braun et al (2007)
Antolin et al (2011)
Kablau and Wedow (2011)
Literature Review:
Problems of measuring Substitution of Assets

Most of the studies had issues with the
availability of the data and which data to
use as a measure for substitution the only
study found to have a complex model was
the one done by Hamburger (1968).
Stylized Facts – Deposits Interest Rates of
USA and World
-15
2000 Jan
2000 May
2000 Sep
2001 Jan
2001 May
2001 Sep
2002 Jan
2002 May
2002 Sep
2003 Jan
2003 May
2003 Sep
2004 Jan
2004 May
2004 Sep
2005 Jan
2005 May
2005 Sep
2006 Jan
2006 May
2006 Sep
2007 Jan
2007 May
2007 Sep
2008 Jan
2008 May
2008 Sep
2009 Jan
2009 May
2009 Sep
2010 Jan
2010 May
2010 Sep
2011 Jan
2011 May
Stylized Facts – Real Interest Rates of
Trinidad and Tobago
20
15
10
5
0
-5
-10
Inflation Rate
Deposit Interest Rate (Avg)
Real Deposit Interest Rate (Avg)
-20
Stylized Facts – Deposits Interest Rates
of Banking Instruments
12
10
%
8
IR12M
IRFD
RBLMMF
SIR
TBR
6
4
2
0
00 01 02 03 04 05 06 07 08 09 10
Years
Stylized Facts – Deposits Interest Rates
of Non-Banking Instruments
15
10
5
0
%
SMR
HPROR
RBLEF
-5
-10
-15
-20
00 01 02 03 04 05 06 07 08 09 10
Years
Commercial Bank Deposits - Demand, Time, Special
Mar-11
Nov-10
Jul-10
Mar-10
Nov-09
Jul-09
Mar-09
Nov-08
Jul-08
Mar-08
Nov-07
Jul-07
Mar-07
Nov-06
Jul-06
Mar-06
Nov-05
Jul-05
Mar-05
Nov-04
Jul-04
Mar-04
Nov-03
Jul-03
Mar-03
20
Nov-02
Jul-02
Mar-02
Nov-01
Jul-01
Mar-01
Stylized Facts – Commercial Bank
Deposits of Trinidad and Tobago
Percent Change in Commercial Bank Deposits
15
10
5
0
-5
-10
Stylized Facts- Demand for Assets
32000
28000
TTS Millions
24000
20000
FCD
DD
SD
TBO
TD
16000
12000
8000
4000
0
00 01 02 03 04 05 06 07 08 09 10 11
Years
Stylized Facts- Demand for Assets
140000
TTS Millions
120000
100000
80000
HP
MC
60000
40000
20000
00 01 02 03 04 05 06 07 08 09 10
Years
Stylized Facts – Deferential of the Interest
Rates to the Savings Interest Rate
10
8
%
6
SPDIR12M
SPDIRFD
SPDMMF
SPDTBR
4
2
0
-2
00 01 02 03 04 05 06 07 08 09 10
Years
Stylized Facts – Deferential of the Interest
Rates to the Savings Interest Rate
12
8
4
0
%
-4
SPDHPR
SPDEF
SPDSMR
-8
-12
-16
-20
-24
00 01 02 03 04 05 06 07 08 09 10
Years
Stylized Facts- Correlations of Interest Rates
Correlation Ratios of Saving
Instruments Interest Rate with
Interest Rate of 12mth
Deposits
1
Correlation Ratios of Saving
Instruments Interest Rate with
House Prices ROR
1
0.5
0.5
0
-0.5
0
TBR
EF
IRFD
SMR
IR6M
MMF
IR3M
IR12M
SIR
Stylized Facts- Correlations of Interest Rates
Correlation Ratios of Saving
Instruments Interest Rate with
Stock Market Rate of Return
1
1
0.5
0.5
0
0
-0.5
-0.5
Correlation Ratios of Saving
Instruments Interest Rate
with Equity Funds Rate of
Return
Stylized Facts- Correlations of Volumes
Correlation Ratios of Saving
Instruments (Volume) with
Savings Deposits (TT$M)
Correlation Ratios of Saving
Instruments (Volume) with
House Prices (TT$M)
1
1
0.5
0.5
0
0
Stylized Facts- Correlations of Volumes
Correlation Ratios of Saving
Instruments (Volume) with
Equity Funds (TT$M)
Correlation Ratios of Saving
Instruments (Volume) with
Mkt Cap. of TTSE (TT$M)
1
1
0.5
0.5
0
0
Implications

Low interest rates is a significant contributor
to the high liquidity problem in TT, because of
the savings deposits have become a holding bay
for all other saving instruments.

The Risk Factor associated with a protracted
period of low interest rates is considerably
high. Investors will be incentivised to take on
more risk by investing in riskier assets.
Implications

The possibility exist that on the foreign
exchange side people are looking outside of
TT for higher returns, given the increase the
demand for foreign currency.

Switching costs restricts substitution across
assets. This may contribute to the excess
liquidity but may also prevent bubbles in the
housing market.
Further Research
This is the initial findings of our analysis
, we are looking to develop a more
complex model of interest rate and
demand for assets that can measure more
accurately the extent of substitution based
on factors such as differentials between
rate of return and risk adverseness.
 To do this same study for Barbados and
Jamaica

Thank You for your
attention .
The University of the West Indies
St. Augustine, Trinidad and Tobago
Phone: (868) 645-1174, Fax: (868) 645-6017
E-Mail: [email protected]
Website: www.ccmfuwi.org