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A re-assessment of the relationship between real exchange rates and real interest rates: 1974-1990

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  • Edison, Hali J.
  • Pauls, B. Dianne

Abstract

The general view of the economics profession is that we can not explain exchange rate movements. However, some researchers still contend that the relationship between real interest rates and the real exchange rate is a useful framework for thinking about exchange rate movements. This paper asks whether there is such a systematic relationship and whether it is revealed by the data. In our attempt to find such a relationship we investigate whether the empirical results are conditional on: (1) the time period selected, (2) the choice of interest rate, (3) the measure of expected inflation, and (4) the choice of exchange rate. The results show that exchange rates and interest rates, both nominal and real are nonstationary; however, they are not cointegrated with each other. On the other hand, the dynamic models indicate that there might be a long-run relationship between these variables, but cannot corroborate this. Consequently, the final conclusion is that the empirical results do not confirm the relationship and this result is robust across exchange rates, time periods, interest rates, and inflation measures.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 31 (1993)
Issue (Month): 2 (April)
Pages: 165-187

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Handle: RePEc:eee:moneco:v:31:y:1993:i:2:p:165-187

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Web page: http://www.elsevier.com/locate/inca/505566

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  1. Edison, Hali J. & Fisher, Eric O'N, 1991. "A long-run view of the European monetary system," Journal of International Money and Finance, Elsevier, vol. 10(1), pages 53-70, March.
  2. John Y. Campbell & Richard H. Clarida, 1988. "The Dollar and Real Interest Rates," NBER Working Papers 2151, National Bureau of Economic Research, Inc.
  3. Engle, Robert F. & Yoo, Byung Sam, 1987. "Forecasting and testing in co-integrated systems," Journal of Econometrics, Elsevier, vol. 35(1), pages 143-159, May.
  4. Hooper, Peter & Morton, John, 1982. "Fluctuations in the dollar: A model of nominal and real exchange rate determination," Journal of International Money and Finance, Elsevier, vol. 1(1), pages 39-56, January.
  5. Coughlin, C.C. & Koedijk, C.G., 1990. "What do we know about the long run real exchange rate?," Open Access publications from Tilburg University urn:nbn:nl:ui:12-3108738, Tilburg University.
  6. Peter C.B. Phillips, 1985. "Time Series Regression with a Unit Root," Cowles Foundation Discussion Papers 740R, Cowles Foundation for Research in Economics, Yale University, revised Feb 1986.
  7. Hendry, David F. & Pagan, Adrian R. & Sargan, J.Denis, 1984. "Dynamic specification," Handbook of Econometrics, in: Z. Griliches† & M. D. Intriligator (ed.), Handbook of Econometrics, edition 1, volume 2, chapter 18, pages 1023-1100 Elsevier.
  8. Andrew C. Harvey, 1990. "The Econometric Analysis of Time Series, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 026208189x, January.
  9. Banerjee, Anindya, et al, 1986. "Exploring Equilibrium Relationships in Econometrics through Static Models: Some Monte Carlo Evidence," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 48(3), pages 253-77, August.
  10. Frankel, Jeffrey A, 1979. "On the Mark: A Theory of Floating Exchange Rates Based on Real Interest Differentials," American Economic Review, American Economic Association, vol. 69(4), pages 610-22, September.
  11. Boughton, James M., 1987. "Tests of the performance of reduced-form exchange rate models," Journal of International Economics, Elsevier, vol. 23(1-2), pages 41-56, August.
  12. Dickey, David A & Fuller, Wayne A, 1981. "Likelihood Ratio Statistics for Autoregressive Time Series with a Unit Root," Econometrica, Econometric Society, vol. 49(4), pages 1057-72, June.
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