DOES REAL INTEREST RATE PARITY HOLD FOR OECD COUNTRIES? NEW EVIDENCE USING PANEL STATIONARITY TESTS WITH CROSS‐SECTION DEPENDENCE AND STRUCTURAL BREAKS

This paper tests for real interest rate parity (RIRP) among the 17 major Organisation for Economic Cooperation and Development countries over the period 1978:Q1–2006:Q1. The econometric methods applied consist of combining the use of panel data tests that are valid under cross‐section dependence and the presence of multiple structural breaks. This feature is important because the misspecification errors due to not accounting for structural breaks and/or cross‐section dependence can lead to misleading conclusions. Our results support the fulfilment of the weak version of the RIRP for short‐term interest rate differentials once dependence and structural breaks are considered.     

Real interest rate parity with Flexible Fourier stationary test for Central and Eastern European countries

This study applies stationary test with a Fourier function proposed by Enders and Lee (2012) to test the validity of long-run real interest rate parity (RIRP) to assess the non-stationary properties of the real interest rate convergence for twelve Central and Eastern European (CEE) countries. We find that our approximation has higher power to detect U-shaped breaks and smooth breaks than linear method if the true data generating process of interest rate convergence is in fact a stationary non-linear process. We examine the validity of RIRP from the non-linear point of view and provide robust evidence clearly indicating that RIRP holds true for nine CEE countries. Our findings point out that their interest rate adjustment is mean reversion towards RIRP equilibrium values in a non-linear way.     

Testing the theory of PPP for emerging market economies that practice flexible exchange rate regimes

This study aims to test the long-run validity of purchasing power parity by using Fourier quantile unit root and Fourier cointegration analyses for 12 emerging market economies that practice a flexible exchange rate regime. With the Fourier approach, structural breaks are modelled as a gradual and smooth process. Fourier quantile unit root test results show that real exchange rate series are stationary for Colombia, India, Philippines, Poland, South Africa, and Turkey. On the other hand, Fourier cointegration test results reveal that purchasing power parity is valid for Brazil, Colombia, India, Mexico, South Africa, Thailand, and Turkey.     

A Test of Long-run Purchasing Power Parity Allowing for Structural Breaks*

If exchange rates and prices are integrated processes, standard econometric tests of the purchasing power parity (PPP) hypothesis may be biased towards rejection. This paper avoids this problem by using the Engle and Granger (1987) theory of cointegrated processes. If the absolute version of purchasing power parity is true, and nominal exchange rates and prices are integrated processes, inter-commodity arbitrage should ensure that the real exchange rate is stationary. The stationarity hypothesis is tested using Australian real exchange rate data for the 1890–1984 period We find that the effective real exchange rate cannot be modelled as a stationary process and therefore reject the absolute version of PPP. We also employ a test for structural breaks due to, for instance, the oil price shock and find mixed results. Another interpretation of our results is that the real exchange rate was affected by a series of permanent, real shocks during the sample period     

Integration or Independence? An Alternative Assessment of Real Interest Rate Linkages in the European Union

The relationship between national real interest rates provides a valuable insight into the extent of economic and financial integration between countries. This paper tests for long‐run parity in ex post real interest rates among the major European Union (EU) countries over the period 1979–2003. The empirical investigation, however, is based on an alternative approach. Strong parity is determined by whether or not the first largest principal component (LPC), based on real interest rate differentials with respect to a chosen base country, is stationary. The qualitative outcome of the test is invariant to the choice of base country, and compared with alternative multivariate tests for long‐run parity, this methodology places less demands on limited data sets. Strong evidence of onshore parity occurs during 1979–1990 and 1993–2003 with the half‐life of a deviation to parity that varies towards 6 months. There is no evidence of long‐run parity among EU members during 1990–1993 despite the easing of remaining capital controls in 1990. Parity is rejected for a sample of non‐EU countries throughout the study period.     

On real interest rate persistence: the role of breaks

The role of structural breaks in long spans of ex-post real interest rates for 10 industrialized countries is studied. First, the persistence of the real interest is assessed with newly proposed low-frequency tests of Müller and Watson (2008). Second, the test of Leybourne et al. (2007) for a change in persistence of a time series is applied to the real interest rate. The results show that real interest rates over the full sample period do not fit a covariance-stationary or unit-root model, nor a fractionally integrated, near-unit-root or local-level model. Instead, the persistence of real rates changes over time and there are periods when the real rate is covariance-stationary and other periods when it follows a unit-root process.     

Parity reversion persistence in real exchange rates: middle income country case

This article investigates purchasing power parity (PPP) in the specific context of middle income countries. To circumvent the low power of traditional stationarity tests (Augmented Dickey-Fuller and Phillips-Perron tests), it performs variance ratio and fractional integration tests in addition to Perron's test that accounts for potential structural changes in real exchange rate processes. Beyond estimating half-life shocks to PPP, this article attempts to explain these estimates using a set of country specific variables as suggested by economic theory. The evidence suggests that reversion to parity tends to be faster in high inflation countries and that productivity improvement leads to a higher level of persistence. Openness to trade tends to reduce the extent of deviations from parity but this result does not appear to be statistically robust. Evidence shows also that deviations are less persistent under a fixed exchange rate regime and under unrestricted capital mobility.     

REAL INTEREST RATE PARITY AND FOURIER QUANTILE UNIT ROOT TEST

Real interest rate differentials usually exhibit two properties; structural breaks and asymmetric dynamics. In this paper, we use various types of Quantile Unit Root Test (QURT) which accounts for both properties. Unlike previous research, we reject the unit root in the real interest rate differentials in 18 out of 21 OECD countries as well as in 4 out of 5 BRICS countries using QURT with sharp and smooth breaks.     

Testing the validity of PPP theory for African countries

This study examines the purchasing power parity theory for 14 African countries by applying a recent composite time series method that incorporates the Fourier approximation. The structural breaks are modelled as a gradual smooth process by means of a Fourier component. The Fourier unit root test failed to find any evidence showing that real exchange rates for these 14 countries have mean-reverting tendencies. However, both cointegration and Fourier cointegration tests detect a stable long-term relation between the nominal exchange rate and relative price levels for 8 out of 14 countries; moreover, for five countries Fourier component in cointegration analysis is found to suit quite well.     

Are real exchanges rate series really persistent?: evidence from three commonwealth of independent states countries

This article sets out to examine the degree of persistence in the real exchange rates of Kazakhstan, Kyrgyzstan and Russia, and tests the validity of Purchasing power parity (PPP) using monthly data covering 1995:01–2013:12 period. The sum of autoregressive (AR) coefficients is used in order to examine persistence of the real exchange rate series and grid-bootstrap method is employed for the confidence intervals. The tests performed suggest two results: (1) Covering the full sample and sub-sample periods, excluding Kyrgyzstan in 1995:01–1998:07 and Russia in 2008:09–2013:12 periods, disregarding the structural breaks in the data generating process, there is high persistency in real exchange rates; (2) there is evidence in support of PPP covering the full sample for every country except for Kyrgyzstan in 1995:01–1998:07 and Russia in 2008:09–2013:12 periods.     

中国实际利率平价的KSS非线性单位根检验

中国一直在进行资本和金融项目的渐进改革,通常描述和刻画这一经济规律变化的是利率平价理论。由于近十几年限制我国利率平价的制度约束条件均得到缓解,所以,本文利用基于ESTAR结构的KSS非线性单位根检验分析法,并连同ADF和PP检验一起对我国实际利率平价进行了实证,检验结果表明,实际利率平价假说成立,并遵循非线性稳态过程,利率的非对称调整导致信贷市场和金融市场的信息不对称。这说明短期内实际利率的调整特征是平滑转移的,在长期内,双边国家均无法实施相对独立的货币政策。     

INTERNATIONAL LABOUR FORCE PARTICIPATION RATES BY GENDER: UNIT ROOT OR STRUCTURAL BREAKS?

This paper examines the possibility of unit roots in the presence of endogenously determined multiple structural breaks in the total, female and male labour force participation rates (LFPR) for Australia, Canada and the USA. We extend the procedure of Gil‐Alana for a single structural break to the case of multiple structural breaks at endogenously determined dates using the principles suggested by Bai and Perron. We use the Robinson LM test to determine the fractional order of integration. We find that endogenously determined structural breaks render the total, female and male LFPR series stationary or at best mean‐reverting.     

Removal of farm subsidies in a regional economy: a computable general equilibrium analysis

There are a number of studies that examine the purchasing power parity (PPP) hypothesis. The empirical findings from the extant literature for the PPP hypothesis are mixed. This article applies univariate and panel Lagrange Multiplier (LM) unit root tests with one and two structural breaks to real exchange rates for 15 Asian countries. The univariate LM unit root tests find evidence of PPP for two-thirds of the sample. The results from the panel LM unit root test support long-run PPP for the Asian countries in the sample. The results from the LM panel unit root tests differ from those of existing panel unit root tests of PPP for Asian countries that have not allowed for the existence of structural breaks.     

FURTHER EVIDENCE ON REAL INTEREST RATE EQUALIZATION: PANEL INFORMATION,NON‐LINEARITIES AND STRUCTURAL CHANGES

Previous studies applying traditional unit root tests generally have difficulty providing widespread evidence supporting the real interest rate parity hypothesis (RIPH). This paper aims to analyse the empirical fulfilment of RIPH for 17 OECD countries by employing many recently developed unit root tests. Power of the tests is raised by taking different approaches, such as using cross‐sectional information, accounting for non‐linear adjustment towards the equilibrium and allowing for structural changes. The combined results of the tests using panel information show that broad evidence in favour of RIPH prevails for 13 of the 17 countries. By contrast, univariate tests fail to make widespread rejections of the unit‐root hypothesis. Our evidence reveals a high degree of market integration for developed countries, and the effect of monetary policies as a stabilization tool might be limited at least in the long run.     

Long-run estimates of money demand: new evidence from East Asian countries and the presence of structural breaks

Conventionally, the money demand function is estimated using a linear regression of the logarithm of money demand on a number of variables. In this article, we aim to estimate the long-run properties of money demand specification for a number of East Asian economies and within a panel framework with the presence of structural breaks. Various country-specific coefficients are allowed to capture inter-country heterogeneities. Consistent with theoretical postulates, it is found that (a) the demand for money in the long-run positively responds to real income and inversely to the interest rate spread, inflation, the real effective exchange rate and the US real interest rate; (b) the long-run income elasticity is greater than unity; and (c) both the currency substitution and capital mobility hypotheses hold. The empirical findings in this article can provide useful policy guidelines to the East Asian countries’ central banks in their quest for price stability. If one of the primary objectives of these countries is to minimize price instability, they should avoid creating unnecessary disequilibrium in the money market, while the employment of cointegration with the presence of structural breaks clearly recommends to central banks to use the supply of money to attain price and macroeconomic stability.     

Real interest rate parity in Asian countries: evidence from the quantile unit root test

This article studies the real interest rate parity (RIP) for several Asian countries. This is done by examining the stationarity in the real interest rate differentials (rids) with respect to the US using the quantile unit root test. Our results show that rids exhibits unit-root behaviours in the lower quantile levels, and mean reversion in the upper quantile levels. Furthermore, large positive shocks tend to induce strong mean reversion and the adjustment towards the long-run equilibrium level is faster as rids gets larger, with shorter half-lives in the extreme quantile levels.     

Re-examining the real interest rate parity hypothesis (RIPH) using panel unit root tests with asymmetry and cross-section dependence

This paper investigates the validity of the real interest rate parity hypothesis (RIPH) using a panel unit root approach. For this purpose, first we estimate the possible nonlinear data-generating processes of the real interest rate differential series and using these estimates determine which panel unit root test is better for analyzing the RIPH. To this end, smooth transition autoregressive and threshold autoregressive (TAR) models are estimated for two different panels of countries: G7 and post-Soviet transition economies. The results show that the data displays both strong asymmetry and high transition speed. Therefore, secondly, we propose a new panel unit root test where the alternative is stationary with asymmetric TAR adjustment, and provide their empirical power properties. Finally, we demonstrate that our newly proposed test is able to provide conclusive evidence in favor of the RIPH in contrast to the other panel unit root tests considered.     

Is the adjustment to real interest rate parity asymmetric?

Threshold cointegration is employed in this study to test the real interest parity condition between the UK and the US. Evidence supports the asymmetric adjustment of real interest rates. The threshold error correction models indicate that negative deviations from long run real interest parity are eliminated faster than positive deviations.     

A revisit on real interest rate parity hypothesis – simulation evidence from efficient unit root tests

A set of unit root tests are applied to test the existence of long-run real interest rate parity among the G-10 countries over the period 1971M1 to 2007M2. Rather than trusting the asymptotic distributions, this article uses simulation techniques to establish the small sample distributions of these tests, conditional on the stationary and nonstationary processes. The empirical results indicate that the tests have stable finite-sample sizes and higher size-adjusted powers such that the two estimated processes can be distinguished from each other. Thus, for six of the nine countries, their series are more likely to come from the estimated Autoregressive (AR) stationary process than from the nonstationary process. Noticeably, the testing results are rather different from those using the asymptotic distributions, in which only three countries support the real interest rate parity.     

Monetary transmission mechanism in Turkey under the monetary conditions index: an alternative policy rule

This study analyses monetary transmission mechanism in Turkey using a small structural macroeconomic model. The core equations of the model consist of aggregate demand, wage-price setting, uncovered interest rate parity, foreign sector and a monetary policy rule. The aim of the paper is to analyse the disinflation path, the output gap, the output level, the exchange rate and the interest rate, and also the output–inflation variance frontier of the economy under various scenarios. The first scenario assumes that a standard Taylor rule is implemented as the policy rule. In the alternative scenario, instead of the standard Taylor rule, the MCI, Monetary Conditions Index – combination of the changes in the short-term real interest rate and in the real effective exchange rate in a single variable – is used as a policy instrument. The results indicate that the economy stabilizes much more quickly and shows significantly less volatility under this new setting. Therefore, the paper concludes that the policymakers should consider using MCI as an instrument when conducting monetary policy.