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A Re-examination of the Link between Real Exchange Rates and Real Interest Rate Differentials

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  • Mathias Hoffmann
  • Ronald MacDonald

Abstract

The real exchange rate - real interest rate (RERI) relationship is central to most open economy macroeconomic models. However, empirical support for the relationship, especially when cointegrationbased methods are used, is rather weak. In this paper we reinvestigate the RERI relationship using bilateral real exchange rate data spanning the period 1978 to 1997. We first clarify the logic of applying cointegration methods to the RERI and propose an alternative way of testing the relationship. We demonstrate that the failure of earlier analyses to detect a stationary real interest rate is largely due to the low power of the tests employed.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 894.

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Date of creation: 2003
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Handle: RePEc:ces:ceswps:_894

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Keywords: real exchange rates; real interest rates; cointegration;

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Cited by:
  1. Weißbach, Rafael & Ponyatovskyy, Vladyslav & Zimmermann, Guido, 2006. "The Yield of Ten-Year T-Bonds: Stumbling Towards a 'Good' Forecast," Technical Reports 2006,50, Technische Universität Dortmund, Sonderforschungsbereich 475: Komplexitätsreduktion in multivariaten Datenstrukturen.
  2. Catherine S. F. Ho & M. Ariff, 2008. "The Role of Non-Parity Fundamentals in Exchange Rate Determination: Australia and the Asia Pacific Region," CARF F-Series, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo CARF-F-125, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
  3. Dette, Holger & Weißbach, Rafael, 2006. "A Bootstrap Test for the Comparison of Nonlinear Time Series - with Application to Interest Rate Modelling," Technical Reports 2006,30, Technische Universität Dortmund, Sonderforschungsbereich 475: Komplexitätsreduktion in multivariaten Datenstrukturen.
  4. Jesús Ferreyra & Jorge Salas, 2006. "The Equilibrium Real Exchange Rate in Peru: BEER Models and Confidence Band Building," Working Papers, Banco Central de Reserva del Perú 2006-006, Banco Central de Reserva del Perú.
  5. Balázs Égert & Ronald MacDonald, 2006. "Monetary Transmission Mechanism in Transition Economies: Surveying the Surveyable," MNB Working Papers, Magyar Nemzeti Bank (the central bank of Hungary) 2006/5, Magyar Nemzeti Bank (the central bank of Hungary).
  6. Minford, Patrick & Peel, David, 2006. "On the Equality of Real Interest Rates Across Borders in Integrated Capital Markets," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5611, C.E.P.R. Discussion Papers.
  7. Mylonidis, Nikolaos & Paleologou, Suzanna-Maria, 2011. "The real uncovered interest parity: The case of Canada and the USA," Journal of Policy Modeling, Elsevier, Elsevier, vol. 33(2), pages 255-267, March.

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