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Real Interest Rate Parity under Regime Shifts and Implications for Monetary Policy

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  • Jyh‐Lin Wu
  • Stilianos Fountas

Abstract

We use recently developed cointegration tests that determine the regime shift endogenously to test for bilateral real interest rate convergence (real interest rate parity) in the G7 against the USA in the 1974–95 period. In contrast with previous studies that employed classical regression analysis and standard cointegration tests, our innovative approach provides strong evidence in favour of bilateral real interest rate convergence between the USA and several countries in our sample, in particular for short‐term real interest rates. Our results highlight the fact that for a number of countries in our sample (Canada and the UK) monetary policy can act as a stabilization policy tool through its effect on domestic long‐term real interest rates, while for others (France and Germany) long‐term real interest rate changes are influenced by the US monetary policy stance.

Suggested Citation

  • Jyh‐Lin Wu & Stilianos Fountas, 2000. "Real Interest Rate Parity under Regime Shifts and Implications for Monetary Policy," Manchester School, University of Manchester, vol. 68(6), pages 685-700, December.
    • Handle: RePEc:bla:manchs:v:68:y:2000:i:6:p:685-700
    DOI: 10.1111/1467-9957.00225
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    Cited by:

    1. Byrne, Joseph P. & Nagayasu, Jun, 2010. "Structural breaks in the real exchange rate and real interest rate relationship," Global Finance Journal, Elsevier, vol. 21(2), pages 138-151.
    2. Baharumshah, Ahmad Zubaidi & Haw, Chan Tze & Fountas, Stilianos, 2005. "A panel study on real interest rate parity in East Asian countries: Pre- and post-liberalization era," Global Finance Journal, Elsevier, vol. 16(1), pages 69-85, August.
    3. Amornthum, Somchai & Bonham, Carl S., 2011. "Financial integration in the pacific basin region: RIP by PANIC attack?," Journal of International Money and Finance, Elsevier, vol. 30(6), pages 1019-1033, October.
    4. Giorgio Canarella & Luis A. Gil-Alana & Rangan Gupta & Stephen M. Miller, 2022. "Globalization, long memory, and real interest rate convergence: a historical perspective," Empirical Economics, Springer, vol. 63(5), pages 2331-2355, November.
    5. Chan, Tze-Haw, 2002. "Dynamic financial linkages among the Asia Pacific economies: an empirical assessment of real interest parity condition," MPRA Paper 34642, University Library of Munich, Germany.
    6. Sirichand, Kavita & Vivian, Andrew & Wohar, Mark E., 2015. "Examining real interest parity: Which component reverts quickest and in which regime?," International Review of Financial Analysis, Elsevier, vol. 39(C), pages 72-83.
    7. Giorgio Canarella & Stephen Miller & Stephen Pollard, 2011. "The Global Financial Crisis and Stochastic Convergence in the Euro Area," International Advances in Economic Research, Springer;International Atlantic Economic Society, vol. 17(3), pages 315-333, August.
    8. Ahmad Zubaidi Baharumshah & Venus Khim‐Sen Liew & Chan Tze Haw, 2009. "The Real Interest Rate Differential: International Evidence Based On Non‐Linear Unit Root Tests," Bulletin of Economic Research, Wiley Blackwell, vol. 61(1), pages 83-94, January.
    9. Maki, Daiki, 2012. "Tests for cointegration allowing for an unknown number of breaks," Economic Modelling, Elsevier, vol. 29(5), pages 2011-2015.
    10. Dreger, Christian, 2010. "Does the Nominal Exchange Rate Regime Affect the Real Interest Parity Condition?," EconStor Open Access Articles and Book Chapters, ZBW - Leibniz Information Centre for Economics, vol. 21(3), pages 274-285.
    11. Ching-Chuan Tsong & Cheng-Feng Lee, 2013. "Further Evidence On Real Interest Rate Equalization: Panel Information, Non-Linearities And Structural Changes," Bulletin of Economic Research, Wiley Blackwell, vol. 65, pages 85-105, May.
    12. Koziol, Philipp, 2014. "Inflation and interest rate derivatives for FX risk management: Implications for exporting firms under real wealth," The Quarterly Review of Economics and Finance, Elsevier, vol. 54(4), pages 459-472.
    13. Christian Upper & Andreas Worms, 2003. "Real long-term interest rates and monetary policy: a cross-country perspective," BIS Papers chapters, in: Bank for International Settlements (ed.), Monetary policy in a changing environment, volume 19, pages 234-257, Bank for International Settlements.
    14. Jana Riedel, 2020. "On real interest rate convergence among G7 countries," Empirical Economics, Springer, vol. 59(2), pages 599-626, August.
    15. Chan Tze-Haw & Ahmad Zubaidi Baharumshah & Evan Lau, 2007. "Real Financial Integration among the East Asian Economies: A SURADF Panel Approach," Capital Markets Review, Malaysian Finance Association, vol. 15(1&2), pages 53-71.
    16. Sekioua, Sofiane H., 2008. "Real interest parity (RIP) over the 20th century: New evidence based on confidence intervals for the largest root and the half-life," Journal of International Money and Finance, Elsevier, vol. 27(1), pages 76-101, February.
    17. Mariam Camarero & Josep Lluís Carrion‐i‐Silvestre & Cecilio Tamarit, 2010. "Does Real Interest Rate Parity Hold For Oecd Countries? New Evidence Using Panel Stationarity Tests With Cross‐Section Dependence And Structural Breaks," Scottish Journal of Political Economy, Scottish Economic Society, vol. 57(5), pages 568-590, November.
    18. Arusha Cooray, 2009. "Is the adjustment to real interest rate parity asymmetric?," Empirica, Springer;Austrian Institute for Economic Research;Austrian Economic Association, vol. 36(4), pages 407-418, November.
    19. Mohsen Bahmani‐Oskooee & Tsangyao Chang & Zahra (Mila) Elmi & Omid Ranjbar, 2019. "Real Interest Rate Parity And Fourier Quantile Unit Root Test," Bulletin of Economic Research, Wiley Blackwell, vol. 71(3), pages 348-358, July.
    20. repec:kap:iaecre:v:17:y:2011:i:3:p:315-333 is not listed on IDEAS
    21. Chang, Ming-Jen & Su, Che-Yi, 2015. "Does real interest rate parity really hold? New evidence from G7 countries," Economic Modelling, Elsevier, vol. 47(C), pages 299-306.
    22. Salah A. Nusair, 2006. "Real Interest Rate Parity: Evidence from Industrialized Countries," Annals of Economics and Finance, Society for AEF, vol. 7(2), pages 425-457, November.
    23. Milan Deskar-Škrbiæ & Antonija Buljan & Mirna Dumèiæ, 2020. "Real interest rate convergence and monetary policy independence in CEE countries," Zbornik radova Ekonomskog fakulteta u Rijeci/Proceedings of Rijeka Faculty of Economics, University of Rijeka, Faculty of Economics and Business, vol. 38(2), pages 349-380.
    24. Nazlioglu, Saban & Kucukkaplan, Ilhan & Kilic, Emre & Altuntas, Mehmet, 2022. "Financial market integration of emerging markets: Heavy tails, structural shifts, nonlinearity, and asymmetric persistence," Research in International Business and Finance, Elsevier, vol. 62(C).
    25. Sofiane H. Sekioua, 2004. "Real interest parity (RIP) over the 20th century: New evidence based on confidence intervals for the dominant root and half-lives of shocks," Money Macro and Finance (MMF) Research Group Conference 2004 91, Money Macro and Finance Research Group.

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