A Re-Examination of the Link between Real Exchange Rates and Real Interest Rate Differentials

33 Pages Posted: 8 Apr 2003

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: March 2003

Abstract

The real exchange rate - real interest rate (RERI) relationship is central to most open economy macroeconomic models. However, empirical support for the relationship, especially when cointegration-based methods are used, is rather weak. In this paper we reinvestigate the RERI relationship using bilateral real exchange rate data spanning the period 1978 to 1997. We first clarify the logic of applying cointegration methods to the RERI and propose an alternative way of testing the relationship. We demonstrate that the failure of earlier analyses to detect a stationary real interest rate is largely due to the low power of the tests employed.

Keywords: Real Exchange Rates, Real Interest Rates, Cointegration

JEL Classification: E43, F31, F41

Suggested Citation

Hoffmann, Mathias and MacDonald, Ronald R., A Re-Examination of the Link between Real Exchange Rates and Real Interest Rate Differentials (March 2003). Available at SSRN: https://ssrn.com/abstract=388622

Mathias Hoffmann

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 (Contact Author)

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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