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Nonlinearity and Structural Change in Interest Rate Reaction Functions for the US, UK and Germany

Mehtap Kesriyeli, Denise Osborn () and Marianne Sensier ()

Centre for Growth and Business Cycle Research Discussion Paper Series from Economics, The Univeristy of Manchester

Abstract: This paper analyses monthly values of the short-term interest rate for the US, the UK and Germany since the early 1980s in the context of possible nonlinearities and changes over time in the interest rate response to the output gap, inflation, past interest rate changes and external variables (world commodity prices and the real exchange rate). The statistical models used are of the smooth transition class, with very substantial evidence of nonlinearity and/or parameter instability uncovered in the interest rate reaction functions for all three countries. These effects are primarily associated with time and changes in interest rates, with different coefficients applying when interest rates are increasing versus when they are decreasing. The reaction function coefficients for both the US and UK are also found to change during the 1980s.

Date: 2004
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