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Real Interest Rates and Real Exchange Rates : Evidence from Indexed Bonds

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Author Info

  • Douglas Laxton

    ()
    (International Monetary Fund)

  • Michael Bleany

    ()
    (University of Nottingham)

Abstract

Uncovered interest parity combined with mean reversion in real exchange rates implies a positive correlation between the real interest rate differential and the level of the real exchange rate. Previous empirical work that has attempted to test for this relationship has found little empirical support. In this paper we show that empirical tests are sensitive to measures of inflationary expectations and the real interest rate. If we employ measures of inflationary expectations and real interest rates from indexed bonds, we find that there is a significant positive correlation between real interest rates and the real exchange rate. We also show that this correlation disappears when we use the types of proxies that previous researchers have relied upon to measure inflationary expectations.

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Bibliographic Info

Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 1999 with number 942.

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Date of creation: 01 Mar 1999
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Handle: RePEc:sce:scecf9:942

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Postal: CEF99, Boston College, Department of Economics, Chestnut Hill MA 02467 USA
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Cited by:
  1. Papa M'B. P. N'Diaye & Douglas Laxton, 2002. "Monetary Policy Credibility and the Unemployment-Inflation Tradeoff," IMF Working Papers 02/220, International Monetary Fund.
  2. Guy Meredith & Yue Ma, 2002. "The Forward Premium Puzzle Revisited," IMF Working Papers 02/28, International Monetary Fund.
  3. Chowdhry, Bhagwan & Roll, Richard & Xia, Yihong, 2004. "Extracting Inflation from Stock Returns to Test Purchasing Power Parity," Working Papers 04-2, University of Pennsylvania, Wharton School, Weiss Center.

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