Real Interest Rate Parity under Regime Shifts and Implications for Monetary Policy

Jyh‐Lin Wu and Stilianos Fountas

Manchester School, 2000, vol. 68, issue 6, 685-700

Abstract: We use recently developed cointegration tests that determine the regime shift endogenously to test for bilateral real interest rate convergence (real interest rate parity) in the G7 against the USA in the 1974–95 period. In contrast with previous studies that employed classical regression analysis and standard cointegration tests, our innovative approach provides strong evidence in favour of bilateral real interest rate convergence between the USA and several countries in our sample, in particular for short‐term real interest rates. Our results highlight the fact that for a number of countries in our sample (Canada and the UK) monetary policy can act as a stabilization policy tool through its effect on domestic long‐term real interest rates, while for others (France and Germany) long‐term real interest rate changes are influenced by the US monetary policy stance.

Date: 2000
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