International Parity Relationships Between Germany and the United States: A Joint Modelling Approach
This paper examines the interrelations between purchasing power parity, uncovered interest parity, the term structure of interest rates and the Fisher real interest rate parity using cointegration analysis. Dynamic adjustment and feed-back effects are estimated jointly in a full system of equations. An important finding is that the very slow, though significant, price adjustment towards sustainable levels of real exchange rates, has been compensated by corresponding changes in the spread of long-term bond rates. Related to this is the strong empirical support for the weak exogeneity of long-term bond rates, signifying the importance of the large US trade deficits (i.e. the low levels of US savings) and, hence, their linkage to international finance. Altogether, the results suggest that the transmission mechanisms over the post Bretton Woods period have been significantly different from standard theoretical assumptions.
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