Nonlinear dynamics of interest rate and inflation
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.
|Date of creation:||17 Sep 2002|
|Date of revision:|
|Contact details of provider:|| Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland|
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