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Real exchange rates and real interest rate differentials: A present value interpretation

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  • Hoffmann, Mathias
  • MacDonald, Ronald

Abstract

Although the real exchange rate-real interest rate (RERI) relationship is central to most open economy macroeconomic models, empirical support for the relationship is generally found to be rather weak. In this paper we re-investigate the RERI relationship using bilateral US real exchange rate data spanning the period 1978-2007. Instead of testing one particular model, we build on Campbell and Shiller [1987. Cointegration tests of present-value models. Journal of Political Economy 95, 1062-1088] to propose a metric of the economic significance of the relationship. Our empirical results provide robust evidence that the RERI link is economically significant and that the real interest rate differential is a reasonable approximation of the expected rate of depreciation over longer horizons.

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Bibliographic Info

Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 53 (2009)
Issue (Month): 8 (November)
Pages: 952-970

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Handle: RePEc:eee:eecrev:v:53:y:2009:i:8:p:952-970

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Keywords: Real exchange rates Real interest rates Present-value model;

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Cited by:
  1. Li, Kui-Wai & Wong, Douglas K T, 2011. "The Exchange Rate and Interest Rate Differential Relationship: Evidence from Two Financial Crises," MPRA Paper 35297, University Library of Munich, Germany.

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