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Nonlinear dynamics of interest rate and inflation

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  • Markku Lanne

    (University of Helsinki)

Abstract

According to several empirical studies, US inflation and nominal interest rates, as well as the real interest rate, can be described as unit root processes. These results imply that nominal interest rates and expected inflation do not move one-for-one in the long run, which is not consistent with the theoretical models. In this paper we introduce a nonlinear bivariate mixture autoregressive model that seems to fit quarterly US data (1952 Q1 – 2000 Q2) reasonably well. It is found that the three-month treasury bill rate and inflation share a common nonlinear component that explains a large part of their persistence. The real interest rate is devoid of this component, indicating one-for-one movement of the nominal interest rate and inflation in the long run and thus stationarity of the real interest rate. Comparisons with a linear vector autoregressive model reveal that in policy analysis the consequences of neglecting nonlinearities can be substantial.

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Bibliographic Info

Paper provided by EconWPA in its series Macroeconomics with number 0405014.

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Date of creation: 14 May 2004
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Handle: RePEc:wpa:wuwpma:0405014

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Keywords: nonlinear models; interest rate; inflation; cointegration analysis;

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Citations

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Cited by:
  1. Kanas, Angelos, 2008. "On real interest rate dynamics and regime switching," Journal of Banking & Finance, Elsevier, vol. 32(10), pages 2089-2098, October.
  2. Sibbertsen, Philipp & Kruse, Robinson, 2007. "Testing for a break in persistence under long-range dependencies," Diskussionspapiere der Wirtschaftswissenschaftlichen Fakultät der Leibniz Universität Hannover dp-381, Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät.
  3. Brzoza-Brzezina, Michal, 2005. "Lending booms in the new EU Member States: will euro adoption matter?," Working Paper Series 0543, European Central Bank.
  4. Kauko, Karlo, 2002. "Links between securities settlement systems: An oligopoly theoretic approach," Research Discussion Papers 27/2002, Bank of Finland.
  5. Stephen Hall & George Hondroyiannis & P. Swamy & George Tavlas, 2010. "The Fisher Effect Puzzle: A Case of Non-Linear Relationship?," Open Economies Review, Springer, vol. 21(1), pages 91-103, February.
  6. Michał Brzoza-Brzezina, 2002. "Estimating the Natural Rate of Interest: A SVAR Approach," National Bank of Poland Working Papers 27, National Bank of Poland, Economic Institute.
  7. Tierney, Heather L.R., 2011. "Real-time data revisions and the PCE measure of inflation," Economic Modelling, Elsevier, vol. 28(4), pages 1763-1773, July.
  8. Michal Brzoza-Brzezina, 2005. "Lending Booms in Europe’s Periphery: South-Western Lessons for Central-Eastern Members," Macroeconomics 0502002, EconWPA.
  9. Rautureau, Nicolas, 2004. "Measuring the long-term perception of monetary policy and the term structure," Research Discussion Papers 12/2004, Bank of Finland.
  10. Pierre L. Siklos & Diana N. Weymark, 2011. "Data Revisions, Gradualism, and US Inflation Pressure in Real Time," Vanderbilt University Department of Economics Working Papers 1110, Vanderbilt University Department of Economics.
  11. Saikkonen, Pentti, 2005. "Stability results for nonlinear error correction models," Journal of Econometrics, Elsevier, vol. 127(1), pages 69-81, July.
  12. Tom Pak-wing Fong & Chun-shan Wong, 2008. "Stress Testing Banks' Credit Risk Using Mixture Vector Autoregressive Models," Working Papers 0813, Hong Kong Monetary Authority.
  13. Peik Granlund, 2004. "Bank exit legislation in US, EU and Japanese financial centres," Finance 0405015, EconWPA.
  14. Hannu Koskinen, 2004. "Modelling of Structural Changes in Demand for Money Cointegration Relations," Finnish Economic Papers, Finnish Economic Association, vol. 17(2), pages 63-72, Autumn.
  15. Pierre L. Siklos & Diana N. Weymark, 2009. "Has Inflation Targeting Improved Monetary Policy? Evaluating Policy Effectiveness in Australia, Canada, and New Zealand," Vanderbilt University Department of Economics Working Papers 0906, Vanderbilt University Department of Economics.
  16. Katarzyna Maciejowska, 2010. "Estimation Methods Comparison of SVAR Models with a Mixture of Two Normal Distributions," Central European Journal of Economic Modelling and Econometrics, CEJEME, vol. 2(4), pages 279-314, September.
  17. Michal Brzoza-Brzezina, 2004. "The Information Content of the Natural Rate of Interest: The Case of Poland," Macroeconomics 0402007, EconWPA.
  18. Maciejowska, Katarzyna, 2013. "Assessing the number of components in a normal mixture: an alternative approach," MPRA Paper 50303, University Library of Munich, Germany.
  19. Kisswani, Khalid/ M. & Nusair, Salah/ A., 2011. "Non-linear convergence in Asian interest rates and inflation rates," MPRA Paper 34179, University Library of Munich, Germany.

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