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Are real interest rates a monetary phenomenon? Evidence from 700 years of data

Author

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  • Plakandaras, Vasilios
  • Gupta, Rangan
  • Karmakar, Sayar
  • Wohar, Mark E.

Abstract

In this paper we examine the effect of permanent inflation shocks on real interest rates, based on a structural Time-Varying Parameter Vector Autoregression (TVP-VAR) model that accounts for parameter instability, using the most extensive annual dataset that accounts for the entire economic history that dates back to 1310 for France, Germany, Holland (the Netherlands), Italy, Japan, Spain, the United Kingdom (U.K.) and the United States (U.S.). The Fisherian hypothesis of a one-to-one movement of inflation to nominal interest rates can only be rejected episodically, in favour of a Mundell-Tobin effect of less than proportional increase in the nominal interest rate to an inflation shock. Our findings suggest that long-run real interest rates of advanced economies have historically remain unaffected by inflation shocks due to a corresponding one-to-one increase in the nominal interest rate. Hence, the conclusions drawn by the majority of the existing literature based on post World War II samples should be treated with caution, due to sample selection bias.

Suggested Citation

  • Plakandaras, Vasilios & Gupta, Rangan & Karmakar, Sayar & Wohar, Mark E., 2023. "Are real interest rates a monetary phenomenon? Evidence from 700 years of data," Research in International Business and Finance, Elsevier, vol. 66(C).
    • Handle: RePEc:eee:riibaf:v:66:y:2023:i:c:s0275531923001368
    DOI: 10.1016/j.ribaf.2023.102010
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    Keywords

    Inflation; Real interest rate; TVP-VAR;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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