Inflation-targeting and real interest rate parity: A bias correction approach |
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| Affiliation: | 1. Departamento de Análisis Económico and ERI-CES, University of Valencia, Facultad de Economía, Campus dels Tarongers, 46022 Valencia, Spain;2. D. Mètodes Quantitatius i Teoria Econòmica and Instituto Desarrollo Social y Paz (IUDESP), Universitat d’Alacant, Spain;1. Department of Mathematics, University of Bayreuth, Germany;2. Department of Economics, University of Bayreuth, Germany;3. Public Choice Research Centre, University of Turku, Finland;1. Finance Group, Nottingham University Business School, Nottingham University,Nottingham NG8 1BB, United Kingdom;2. Department of Economics and Finance, Durham University Business School, Durham University, Mill Hill Lane, Durham DH1 3LB, United Kingdom |
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| Abstract: | This paper investigates whether inflation-targeting influences real interest rate parity (RIP) by a bias correction approach under cross-sectional dependence. The recursive mean adjustment (RMA) method proposed by So and Shin (1999) and Shin and So (2001) is employed to correct the downward bias in the panel unit root tests and in the half-life estimates of real interest rate differentials for traded and non-traded goods. The empirical findings differ depending on whether we apply the RMA. More importantly, the empirical results show that as more homogeneous economies become involved in terms of inflation-targeting regime, stronger mean reversion and much a tighter confidence interval are present. Thus, inflation-targeting plays an important role in providing favorable evidence for long-run RIP. |
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| Keywords: | Real interest rate parity Inflation-targeting Recursive mean adjustment Cross-sectional dependence Panel unit root Half-life |
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