The Contribution of Growth and Interest Rate Differentials to the Persistence of Real Exchange Rates

34 Pages Posted: 12 Aug 2006

See all articles by Dimitrios Malliaropulos

Dimitrios Malliaropulos

University of Piraeus - Department of Banking and Financial Management; National Bank of Greece

Ekaterini Panopoulou

Essex Business School

Theologos Pantelidis

University of Kent

Nikitas Pittis

University of Piraeus - Department of Banking and Financial Management

Date Written: April 2006

Abstract

This paper employs a new methodology for measuring the contribution of growth and interest rate differentials to the half-life of deviations from Purchasing Power Parity (PPP). Our method is based on directly comparing the impulse response function of a VAR model, where the real exchange rate is Granger caused by these variables with the impulse response function of a univatiate ARMA model for the real exchange rate. We show that the impulse response function of the VAR model is not, in general, the same with the impulse response function obtained from the equivalent ARMA representation, if the real exchange rate is Granger caused by other variables in the system. The difference between the two functions captures the effects of the Granger-causing variables on the half-life of deviations from PPP. Our empirical results for a set of four currencies suggest that real and nominal long term interest rate differentials and real GDP growth differentials account for 22% to 50% of the half-life of deviations from PPP.

Keywords: real exchange rate, persistence measures, VAR, impulse response function, PPP

JEL Classification: F31, C32

Suggested Citation

Malliaropulos, Dimitrios and Panopoulou, Ekaterini and Pantelidis, Theologos and Pittis, Nikitas, The Contribution of Growth and Interest Rate Differentials to the Persistence of Real Exchange Rates (April 2006). IIIS Discussion Paper No. 135, Available at SSRN: https://ssrn.com/abstract=923778 or http://dx.doi.org/10.2139/ssrn.923778

Dimitrios Malliaropulos

University of Piraeus - Department of Banking and Financial Management ( email )

80 Karaoli & Dimitriou Str.
18534 Piraeus, 185 34 -GR
Greece
(+30) 210 3341527 (Phone)
(+30) 210 3341702 (Fax)

National Bank of Greece ( email )

86 Eolou Str.
10232 Athens
Greece
+30 1 3251133 (Fax)

Ekaterini Panopoulou (Contact Author)

Essex Business School ( email )

Wivenhoe Park
Colchester, CO4 3SQ
United Kingdom

Theologos Pantelidis

University of Kent ( email )

Canterbury, Kent CT2 7PE
United Kingdom

Nikitas Pittis

University of Piraeus - Department of Banking and Financial Management ( email )

80 Karaoli & Dimitriou Str.
18534 Piraeus, 185 34 -GR
Greece

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