International Interest-Rate and Price-Level Linkages Under Flexible Exchange Rates: A Review of Recent Evidence

60 Pages Posted: 1 Jun 2004

See all articles by Robert E. Cumby

Robert E. Cumby

Georgetown University - Department of Economics; National Bureau of Economic Research (NBER)

Maurice Obstfeld

University of California, Berkeley - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Date Written: February 1985

Abstract

In an open economy, the scope for activist stabilization policy depends on the nature of the lincages between domestic and international markets for goods and assets. Tgo important relationships--purchasing power parity and uncovered interest-rate parity--have received extensive empirical atpention in recent years and are fundamental building blocks of several eipirical ex- change rate models. This paper reviews and extends recent econometric findings on these two classical parity relationships and on their corollary, the international equality of expected real interest rates. Econometric tests assuming rationality of expectations are on the whole unfavorable to the classical parity relationships: with few exceptions, they are strongly rejected. A central theme in the review of empirical work is the conditional heteroskedasticity of inflation and exchange rate forecast errors and the bias this statistical problem may impart to tests of inter- national parity relationships. The paper proposes and implements a test for conditional heteroskedasticity which in many cases produces strong evidence that the problem is indeed important.

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Suggested Citation

Cumby, Robert E. and Obstfeld, Maurice, International Interest-Rate and Price-Level Linkages Under Flexible Exchange Rates: A Review of Recent Evidence (February 1985). NBER Working Paper Series, Vol. w0921, pp. -, 1985. Available at SSRN: https://ssrn.com/abstract=299796

Robert E. Cumby

Georgetown University - Department of Economics ( email )

580 Intercultural Center
Washington, DC 20057
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National Bureau of Economic Research (NBER)

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Maurice Obstfeld (Contact Author)

University of California, Berkeley - Department of Economics ( email )

549 Evans Hall #3880
Berkeley, CA 94720-3880
United States
510-643-9646 (Phone)
510-642-6615 (Fax)

HOME PAGE: http://emlab.berkeley.edu/users/obstfeld/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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