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The Real Interest Differential Model after Twenty Years

Author

Listed:
  • Alan G. Isaac

    (American University)

  • Suresh de Mel

    (American University)

Abstract

It has been twenty years since Frankel (1979) offered the classic empirical support for the Dornbusch (1976) overshooting model against the simple monetary approach model, and almost that long since Driskill and Sheffrin (1981) uncovered some important inconsistencies between Frankel’s theoretical framework and his empirical implementation. Frankel’s RID model nevertheless spawned a huge lit-erature in international monetary economics. In this paper, we replicate and update the Frankel (1979) and Driskill and Sheffrin (1981) results, in order to offer a retrospective and a reëvaluation of this lit-erature. We also explain why the model estimated by Driskill and Sheffrin (1981) cannot underpin a critique of Frankel (1979), a point which is not generally recognized. While specialists in international finance generally recognize that the initial promise of Frankel’s research has not been kept, we believe that many will be surprised nevertheless by our stark findings. JEL: F31, F40, C13

Suggested Citation

  • Alan G. Isaac & Suresh de Mel, 1999. "The Real Interest Differential Model after Twenty Years," International Finance 9907002, University Library of Munich, Germany.
    • Handle: RePEc:wpa:wuwpif:9907002
    Note: Type of Document - PDF; prepared on PC with TrueTeX and Acrobat 4; to print on HP; pages: 27 ; figures: included. Comments appreciated.
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    References listed on IDEAS

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    1. Baillie, Richard T. & Selover, David D., 1987. "Cointegration and models of exchange rate determination," International Journal of Forecasting, Elsevier, vol. 3(1), pages 43-51.
    2. David Backus, 1984. "Empirical Models of the Exchange Rate: Separating the Wheat from the Chaff," Canadian Journal of Economics, Canadian Economics Association, vol. 17(4), pages 824-846, November.
    3. Frankel, Jeffrey A, 1979. "On the Mark: A Theory of Floating Exchange Rates Based on Real Interest Differentials," American Economic Review, American Economic Association, vol. 69(4), pages 610-622, September.
    4. Isaac, Alan G., 1996. "Mononic saddle-path dynamics," Economics Letters, Elsevier, vol. 53(3), pages 235-238, December.
    5. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
    6. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-1176, December.
    7. Isaac, Alan G., 1998. "Risk premia and overshooting," Economics Letters, Elsevier, vol. 61(3), pages 359-364, December.
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    Keywords

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    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F40 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - General
    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General

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