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Nonlinear dynamics of interest rate and inflation

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  • Markku Lanne

    (University of Helsinki)

Abstract

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.

Suggested Citation

  • Markku Lanne, 2004. "Nonlinear dynamics of interest rate and inflation," Macroeconomics 0405014, EconWPA.
  • Handle: RePEc:wpa:wuwpma:0405014 Note: Type of Document - pdf
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    References listed on IDEAS

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    1. Markku Lanne & Pentti Saikkonen, 2003. "Modeling the U.S. Short-Term Interest Rate by Mixture Autoregressive Processes," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 1(1), pages 96-125.
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    Cited by:

    1. Michal Brzoza-Brzezina, 2004. "The Information Content of the Natural Rate of Interest: The Case of Poland," Macroeconomics 0402007, EconWPA.
    2. Philipp Sibbertsen & Robinson Kruse, 2009. "Testing for a break in persistence under long-range dependencies," Journal of Time Series Analysis, Wiley Blackwell, vol. 30(3), pages 263-285, May.
    3. Kanas, Angelos, 2008. "On real interest rate dynamics and regime switching," Journal of Banking & Finance, Elsevier, vol. 32(10), pages 2089-2098, October.
    4. Kauko, Karlo, 2002. "Links between securities settlement systems : An oligopoly theoretic approach," Research Discussion Papers 27/2002, Bank of Finland.
    5. O Bajo-Rubio & C Diaz-Roldan & V Esteve, 2010. "Testing the Fisher effect in the presence of structural change: A case study of the UK, 1966-2007," Economic Issues Journal Articles, Economic Issues, vol. 15(2), pages 1-16, September.
    6. Tierney, Heather L.R., 2011. "Real-time data revisions and the PCE measure of inflation," Economic Modelling, Elsevier, vol. 28(4), pages 1763-1773, July.
    7. Katarzyna Maciejowska, 2010. "Estimation Methods Comparison of SVAR Models with a Mixture of Two Normal Distributions," Central European Journal of Economic Modelling and Econometrics, CEJEME, vol. 2(4), pages 279-314, September.
    8. Hannu Koskinen, 2004. "Modelling of Structural Changes in Demand for Money Cointegration Relations," Finnish Economic Papers, Finnish Economic Association, vol. 17(2), pages 63-72, Autumn.
    9. Kalliovirta, Leena & Meitz, Mika & Saikkonen, Pentti, 2016. "Gaussian mixture vector autoregression," Journal of Econometrics, Elsevier, vol. 192(2), pages 485-498.
    10. Maciejowska, Katarzyna, 2013. "Assessing the number of components in a normal mixture: an alternative approach," MPRA Paper 50303, University Library of Munich, Germany.
    11. Michał Brzoza-Brzezina, 2006. "The information content of the neutral rate of interest," The Economics of Transition, The European Bank for Reconstruction and Development, vol. 14(2), pages 391-412, April.
    12. Brzoza-Brzezina, Michał, 2005. "Lending booms in the new EU Member States: will euro adoption matter?," Working Paper Series 543, European Central Bank.
    13. Panopoulou, Ekaterini & Pantelidis, Theologos, 2016. "The Fisher effect in the presence of time-varying coefficients," Computational Statistics & Data Analysis, Elsevier, pages 495-511.
    14. Jesús Clemente & María Dolores Gadea & Antonio Montañés & Marcelo Reyes, 2017. "Structural Breaks, Inflation and Interest Rates: Evidence from the G7 Countries," Econometrics, MDPI, Open Access Journal, vol. 5(1), pages 1-17, February.
    15. Alfred A. Haug & Pierre L. Siklos, 2002. "The Term Spread International Evidence of Non-Linear Adjustment," Working Papers 2002_08, York University, Department of Economics, revised Jul 2004.
    16. Ana Beatriz Galvão & Michael Artis & Massimiliano Marcellino, 2007. "The transmission mechanism in a changing world," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 22(1), pages 39-61.
    17. Shiu-Sheng Chen, 2007. "Does Monetary Policy Have Asymmetric Effects on Stock Returns?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(2-3), pages 667-688, March.
    18. Stephen Hall & George Hondroyiannis & P. Swamy & George Tavlas, 2010. "The Fisher Effect Puzzle: A Case of Non-Linear Relationship?," Open Economies Review, Springer, vol. 21(1), pages 91-103, February.
    19. Peik Granlund, 2004. "Bank exit legislation in US, EU and Japanese financial centres," Finance 0405015, EconWPA.
    20. Michał Brzoza-Brzezina, 2002. "Estimating the Natural Rate of Interest: A SVAR Approach," NBP Working Papers 27, Narodowy Bank Polski, Economic Research Department.
    21. Saikkonen, Pentti, 2005. "Stability results for nonlinear error correction models," Journal of Econometrics, Elsevier, vol. 127(1), pages 69-81, July.
    22. Chiu, Ching-Wai (Jeremy) & Mumtaz, Haroon & Pinter, Gabor, 2016. "VAR models with non-Gaussian shocks," LSE Research Online Documents on Economics 86238, London School of Economics and Political Science, LSE Library.
    23. Tsong, Ching-Chuan & Lee, Cheng-Feng, 2013. "Quantile cointegration analysis of the Fisher hypothesis," Journal of Macroeconomics, Elsevier, pages 186-198.
    24. Kushal Banik Chowdhury & Nityananda Sarkar, 2015. "The Effect of Inflation on Inflation Uncertainty in the G7 Countries: A Double Threshold GARCH Model," International Econometric Review (IER), Econometric Research Association, vol. 7(1), pages 34-50, April.
    25. Tolga Omay & Ayşegül Çorakcı & Furkan Emirmahmutoglu, 2017. "Real interest rates: nonlinearity and structural breaks," Empirical Economics, Springer, pages 283-307.

    More about this item

    Keywords

    nonlinear models; interest rate; inflation; cointegration analysis;

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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