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An Analysis of the Real Interest Rate Under Regime Shifts

  • René Garcia
  • Pierre Perron

This study considers the time series behavior of the U.S. real interest rate from 1961 to 1986. We provide a statistical characterization of the series using the methodology of Hamilton (1989), by allowing three possible regimes affecting both the mean and variance of the series. The results suggest that the ex-post real interest rate is essentially random around a mean that is different for the periods 1961-1973, 1973-1980 and 1980-1986. The variance of the process is also different in these episodes being higher in both the 1973-1980 and 1980-1986 sub-periods. The inflation rate series is also analyzed using a three regime framework and again our results show interesting patterns with shifts in both mean and variance. Various model selection tests are run and both an ex-ante real interest rate and an expected inflation series are constructed. Finally, we make clear how our results can explain some recent findings in the literature. Cette étude s'intéresse au comportement des séries du taux d'intérêt réel américain de 1961 à 1986. En utilisant la méthodologie d'Hamilton (1989), la modélisation statistique des séries se fait en postulant trois régimes possibles affectant la moyenne et la variance de celles-ci. Les résultats suggèrent que le taux d'intérêt réel ex-post est essentiellement un processus non corrélé et centré sur une moyenne qui diffère sur les périodes 1961-1973, 1973-1980 et 1980-1986. La variance du processus est aussi différente pour chacune de ces périodes, étant plus élevée dans les sous périodes 1973-1980 et 1980-1986. Les séries du taux d'inflation sont aussi analysées à la lumière de ce modèle à trois régimes et les résultats traduisent encore un comportement intéressant de celles-ci, avec des changements dans la moyenne et la variance. Différents tests de spécification sont utilisés et des séries, à la fois du taux d'intérêt réel ex-ante et de l'inflation anticipée, sont construites. Enfin, il est montré comment ces résultats peuvent expliquer certaines conclusion récentes de la littérature.

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Paper provided by CIRANO in its series CIRANO Working Papers with number 95s-05.

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Length: 30 pages
Date of creation: 01 Feb 1995
Date of revision:
Handle: RePEc:cir:cirwor:95s-05
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  1. René Garcia, 1995. "Asymptotic Null Distribution of the Likelihood Ratio Test in Markov Switching Models," CIRANO Working Papers 95s-07, CIRANO.
  2. Garbade, Kenneth & Wachtel, Paul, 1978. "Time variation in the relationship between inflation and interest rates," Journal of Monetary Economics, Elsevier, vol. 4(4), pages 755-765, November.
  3. Lamoureux, Christopher G & Lastrapes, William D, 1990. "Persistence in Variance, Structural Change, and the GARCH Model," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(2), pages 225-34, April.
  4. Donald W.K. Andrews, 1988. "Heteroskedasticity and Autocorrelation Consistent Covariance Matrix Estimation," Cowles Foundation Discussion Papers 877R, Cowles Foundation for Research in Economics, Yale University, revised Jul 1989.
  5. Carl E. Walsh, 1987. "Three questions concerning nominal and real interest rates," Economic Review, Federal Reserve Bank of San Francisco, issue Fall, pages 5-19.
  6. Mishkin, F.S., 1988. "What Does The Term Structure Tell Us About Future Inflation?," Papers fb-_88-29, Columbia - Graduate School of Business.
  7. John Huizinga & Frederic S. Mishkin, 1984. "Inflation and Real Interest Rates on Assets with Different Risk Characteristics," NBER Working Papers 1333, National Bureau of Economic Research, Inc.
  8. Hamilton, James D., 1990. "Analysis of time series subject to changes in regime," Journal of Econometrics, Elsevier, vol. 45(1-2), pages 39-70.
  9. John Y. Campbell & Pierre Perron, 1991. "Pitfalls and Opportunities: What Macroeconomists Should Know About Unit Roots," NBER Chapters, in: NBER Macroeconomics Annual 1991, Volume 6, pages 141-220 National Bureau of Economic Research, Inc.
  10. Logue, Dennis E & Willett, Thomas D, 1976. "A Note on the Relation between the Rate and Variability of Inflation," Economica, London School of Economics and Political Science, vol. 43(17), pages 151-58, May.
  11. Olivier J. Blanchard & Lawrence H. Summers, 1984. "Perspectives on High World Real Interest Rates," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 15(2), pages 273-334.
  12. Gokey, T.C., 1990. "Stationarity Of Nominal Interest Rates, Inflation, And Real Interest Rates," Economics Series Working Papers 99105, University of Oxford, Department of Economics.
  13. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-84, March.
  14. Russell Davidson & James G. MacKinnon, 1980. "Several Tests for Model Specification in the Presence of Alternative Hypotheses," Working Papers 378, Queen's University, Department of Economics.
  15. Robert J. Shiller, 1979. "Can the Fed Control Real Interest Rates?," NBER Working Papers 0348, National Bureau of Economic Research, Inc.
  16. Andrews, Donald W K, 1993. "Tests for Parameter Instability and Structural Change with Unknown Change Point," Econometrica, Econometric Society, vol. 61(4), pages 821-56, July.
  17. Marco antonio Bonomo & Rene Garcia, 1992. "Consumption and equilibrium asset pricing: An empirical assessment," Textos para discussão 284, Department of Economics PUC-Rio (Brazil).
  18. Perron, Pierre, 1990. "Testing for a Unit Root in a Time Series with a Changing Mean," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(2), pages 153-62, April.
  19. Hansen, Bruce E, 1992. "The Likelihood Ratio Test under Nonstandard Conditions: Testing the Markov Switching Model of GNP," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 7(S), pages S61-82, Suppl. De.
  20. Fischer, Stanley, 1981. "Towards an understanding of the costs of inflation: II," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 15(1), pages 5-41, January.
  21. Friedman, Milton, 1977. "Nobel Lecture: Inflation and Unemployment," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 451-72, June.
  22. Ahn, Chang Mo & Thompson, Howard E, 1988. " Jump-Diffusion Processes and the Term Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 43(1), pages 155-74, March.
  23. Antoncic, Madelyn, 1986. "High and Volatile Real Interest Rates: Where Does the Fed Fit In?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 18(1), pages 18-27, February.
  24. Taylor, John B., 1981. "On the relation between the variability of inflation and the average inflation rate," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 15(1), pages 57-85, January.
  25. Robert B. Davies, 2002. "Hypothesis testing when a nuisance parameter is present only under the alternative: Linear model case," Biometrika, Biometrika Trust, vol. 89(2), pages 484-489, June.
  26. Nelson, Charles R & Schwert, G William, 1977. "Short-Term Interest Rates as Predictors of Inflation: On Testing the Hypothesis That the Real Rate of Interest is Constant," American Economic Review, American Economic Association, vol. 67(3), pages 478-86, June.
  27. Fama, Eugene F. & Gibbons, Michael R., 1982. "Inflation, real returns and capital investment," Journal of Monetary Economics, Elsevier, vol. 9(3), pages 297-323.
  28. Banerjee, Anindya & Lumsdaine, Robin L & Stock, James H, 1992. "Recursive and Sequential Tests of the Unit-Root and Trend-Break Hypotheses: Theory and International Evidence," Journal of Business & Economic Statistics, American Statistical Association, vol. 10(3), pages 271-87, July.
  29. Foster, Edward, 1978. "The Variability of Inflation," The Review of Economics and Statistics, MIT Press, vol. 60(3), pages 346-50, August.
  30. Rose, Andrew Kenan, 1988. " Is the Real Interest Rate Stable?," Journal of Finance, American Finance Association, vol. 43(5), pages 1095-1112, December.
  31. Goldfeld, Stephen M. & Quandt, Richard E., 1973. "A Markov model for switching regressions," Journal of Econometrics, Elsevier, vol. 1(1), pages 3-15, March.
  32. Frederic S. Mishkin, 1981. "The Real Interest Rate: An Empirical Investigation," NBER Working Papers 0622, National Bureau of Economic Research, Inc.
  33. Fama, Eugene F, 1975. "Short-Term Interest Rates as Predictors of Inflation," American Economic Review, American Economic Association, vol. 65(3), pages 269-82, June.
  34. Huizinga, John & Mishkin, Frederic S., 1986. "Monetary policy regime shifts and the unusual behavior of real interest rates," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 24(1), pages 231-274, January.
  35. Engle, Robert F, 1983. "Estimates of the Variance of U.S. Inflation Based upon the ARCH Model," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 15(3), pages 286-301, August.
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