Integration or Independence? An Alternative Assessment of Real Interest Rate Linkages in the European Union

21 Pages Posted: 6 Dec 2005

See all articles by Mark J. Holmes

Mark J. Holmes

University of Waikato - Management School, Department of Economics

Abstract

The relationship between national real interest rates provides a valuable insight into the extent of economic and financial integration between countries. This paper tests for longrun parity in ex post real interest rates among the major European Union (EU) countries over the period 1979-2003. The empirical investigation, however, is based on an alternative approach. Strong parity is determined by whether or not the first largest principal component (LPC), based on real interest rate differentials with respect to a chosen base country, is stationary. The qualitative outcome of the test is invariant to the choice of base country, and compared with alternative multivariate tests for longrun parity, this methodology places less demands on limited data sets. Strong evidence of onshore parity occurs during 1979-1990 and 1993-2003 with the halflife of a deviation to parity that varies towards 6 months. There is no evidence of longrun parity among EU members during 1990-1993 despite the easing of remaining capital controls in 1990. Parity is rejected for a sample of nonEU countries throughout the study period.

Suggested Citation

Holmes, Mark J., Integration or Independence? An Alternative Assessment of Real Interest Rate Linkages in the European Union. Economic Notes, Vol. 34, No. 3, pp. 407-427, November 2005, Available at SSRN: https://ssrn.com/abstract=856686 or http://dx.doi.org/10.1111/j.0391-5026.2005.00156.x

Mark J. Holmes (Contact Author)

University of Waikato - Management School, Department of Economics ( email )

Hamilton
New Zealand

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