Real Exchange Rates and Real Interest Rate Differentials: A Present Value Interpretation

47 Pages Posted: 23 Mar 2009

See all articles by Mathias Hoffmann

Mathias Hoffmann

University of Zurich - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Ronald MacDonald

University of Strathclyde in Glasgow - Department of Economics; Government of New Zealand - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Date Written: February 2, 2009

Abstract

Although the real exchange rate - real interest rate (RERI) relationship is central to most open economy macroeconomic models, empirical support for the relationship is generally found to be rather weak. In this paper we re-investigate the RERI relationship using bilateral U.S. real exchange rate data spanning the period 1978 to 2007. Instead of testing one particular model, we build on Campbell and Shiller (1987) to propose a metric of the economic significance of the relationship. Our empirical results provide robust evidence that the RERI link is economically significant and that the real interest rate differential is a reasonable approximation of the expected rate of depreciation over longer horizons.

Keywords: Real Exchange Rates, Real Interest Rates, Present Value Model

JEL Classification: E43, F31, F41

Suggested Citation

Hoffmann, Mathias and MacDonald, Ronald R., Real Exchange Rates and Real Interest Rate Differentials: A Present Value Interpretation (February 2, 2009). Available at SSRN: https://ssrn.com/abstract=1365251 or http://dx.doi.org/10.2139/ssrn.1365251

Mathias Hoffmann (Contact Author)

University of Zurich - Department of Economics ( email )

Zuerich, 8006
Switzerland

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Ronald R. MacDonald

University of Strathclyde in Glasgow - Department of Economics ( email )

100 Cathedral Street
Glasgow G4 0LN
United Kingdom
+44 141 548 3861 (Phone)

Government of New Zealand - Department of Economics

2 The Terrace
P.O. Box 2498
Wellington
New Zealand

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

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