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Nonlinear dynamics of interest rate and inflation

  • Markku Lanne

    (School of Business and Economics, University of Jyväskylä, Jyväskylä, Finland)

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 incongruent with theoretical models. In this paper we introduce a new nonlinear bivariate mixture autoregressive model that seems to fit quarterly US data (1953 : II-2004 : IV) 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, hence, stationarity of the real interest rate. Copyright © 2006 John Wiley & Sons, Ltd.

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File URL: http://hdl.handle.net/10.1002/jae.908
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Article provided by John Wiley & Sons, Ltd. in its journal Journal of Applied Econometrics.

Volume (Year): 21 (2006)
Issue (Month): 8 ()
Pages: 1157-1168

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Handle: RePEc:jae:japmet:v:21:y:2006:i:8:p:1157-1168
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  2. Perron, P, 1988. "The Great Crash, The Oil Price Shock And The Unit Root Hypothesis," Papers 338, Princeton, Department of Economics - Econometric Research Program.
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